Income Tax Appellate Tribunal - Ahmedabad
Rakeshbhai K.Patel, Ahmedabad vs Assessee
IN THE INCOME TAX APPELLATE TRIBUNAL
AHMEDABAD BENCH "A"
Before Shri T.K.SHARMA, JUDICIAL MEMBER and
Shri N.S. SAINI, ACCOUNTANT MEMBER
Date of Drafted on
ITA No.1249/AHD/2006
Assessment Year : 2002-2003
Shri Rakeshbhai K Patel, Vs. The Assistant Commissioner of
Nirma House, Ashram Income-tax, Central Circle-
Road, 1(1), Ahmedabad
Ahmedabad
PAN/GIR No. : AGGPP 2910 C
(APPELLANT) .. (RESPONDENT)
Appellant by: Shri S N Soparkar with
Shri Himanshu Shah
Respondent by: Shri Rajeev Agarwal, CIT - DR
ORDER
PER N.S.SAINI (ACCOUNTANT MEMBER):- This is an appeal filed by the assessee against the order of the Learned Commissioner of Income-tax (Appeals)-I, Ahmedabad [the "CIT(A)" for short] dated 08-03-2006 in Appeal No. CIT[A]-I/CC.I(1)/51/05-06.
2 Ground No.1 is general in nature and does not require any adjudication by us.
3 Ground Nos.2 raised by the assessee in this appeal is as under:
2 In law and in facts and circumstances of the Appellant's case, the Ld. Commissioner of Income-tax (Appeals) has erred in confirming the action of ld. Assessing Officer holding that the method of accounting as mercantile as against cash method of accounting regularly followed by the appellant.
The Learned Assessing Officer observed as under:
-2-"2.1 Method of accounting.
4 From the notes forming part of the return of income, it has been found that the assessee has mentioned that he is following the cash system of accounting. But from the Block assessment order dated 28-10-03, it has been found that the AO has considered the method of accounting in the case of the assessee as 'mercantile'. From the appellate order dated 16-12-04, it has been found that the assessee has not taken any ground before Ld. CIT(A) and no finding has been given by him in this regard. Since the order of Ld. CIT(A) merges with the order of the AO it is clear that the assessee has no objection with this finding of the AO and he has accepted that he is following the mercantile system of accounting. The assessee was given the show cause notice dated 14-03-05 to explain as to why in the light of the sec. 145 of IT Act the method of accounting should be considered as 'mercantile' in the case of the assessee in this year also. The relevant portion of this show cause notice is produced as under:
"Please refer to the Block assessment order dated 28-10-03, in this order the AO has decided that the method of accounting in your case is mercantile; you have not taken any ground of appeal before Ld. CIT(A), this means that you have accepted the same. But in the RoI of this year, on the notes forming part of the RoI, you have stated that the assessee is following the cash system of accounting. This RoI was filed on 09-08- 02, and therefore it is clear that the AO has passed the Block order after this date.
Explain as to why as per sec. 145 of IT Act the system of accounting should not be considered as mercantile since it has to be taken on continuous basis and it cannot be changed."
In his submission the representative of the assessee tried to justify that the same should be considered as 'cash' but the contention and the submission of the assessee is not tenable since as per sec. 145 of IT Act, the assessee can adopt only one system of accounting on the regular basis. This section 145 of the Act is produced as under:
"145 Method of accounting.
(1) Income chargeable under the head "Profits and gains of business or profession" or "Income from other sources"
shall, subject to the provisions of sub-section (2), be -3- computed in accordance with either cash or mercantile system of accounting regularly employed by the assessee.
(2) The Central Government may notify in the Official Gazette from time to time accounting standards to be followed by any class of assessees or in respect of any class of income.
(3) Where the AO is not satisfied about the correctness or completeness of the accounts of the assessee, or where the method of accounting provided in sub-section (1) or accounting standards as notified under sub-section (2), have not been regularly followed by the assessee, the AO may take an assessment in the manner provided in section
144. Since in the Block assessment order the AO has decided the method of accounting in the case of the assessee as 'mercantile' and the assessee has not challenged the same on appeal, the Ld. CIT(A) has also passed the order dated 16-12-04, it is concluded that as per the provisions of the Act, the assessee cannot change the same. The assessee is bound to follow the same method of accounting on continuous basis and he is not permitted to change the same. Hence the method of accounting is considered in the case of the assessee as 'mercantile'."
4 Ground No.3 in the appeal reads as under:"In law and in facts and circumstances of the Appellant's case, the Ld. Commissioner of Income-tax (Appeals) has erred in has erred in upholding the action of ld. Assessing Officer in considering the long term capital gain of Rs.1,44,50,000/- arising on transfer in pursuance to re-purchase of 850 Deep Discount Bonds (DDB) series-A issued by Nirma Limited as interest income."
5 The Learned Assessing Officer observed as under:-
"4. Income shown as LTCG instead of STCG From the Annexure 1 of statement of income, it was found that the assessee has shown LTCG of Rs.3,66,00,222/- from the transactions of the DDBs of Nirmal Limited, purchase cost of the same has been shown at Rs.18,52,00,000/- and the same has been shown to have been sold at Rs.22,18,00,222/-. Assessee has claimed the deduction u/s 54EC of I.T. Act since he has made investments in the bonds of Rural Electrification Corporation of Rs.3,66,00,000/-. Therefore the net LTCG of only Rs.222/- has been offered by the assessee.-4-
From the primary details furnished by the assessee, it has been found that 1852 DDBs of Nirma Limited each amounting to Rs.1,00,000/- were allotted to the assessee on 28-07-2000, the letter of allotment for the same was issued to the assessee dated 23-09- 2000. The debenture certificate was issued to the assessee dated 10- 05-2001. This DDB Series A of Nirma Limited was listed in National Stock Exchange on 20-09-2001 and was made available for dematerialization as on 19-09-2001.
Out of these total 1852 DDBs of Nirma Limited, 850 DDBs were repurchased by Nirma Limited, itself dated 01-10-2001 and another 1002 DDBs were sold on 19-03-2002.
From the details furnished by the assessee, it was found that this DDB Series A of Nirma Limited was result of the terms of the Debenture Trust Deed dated 27-4-2001, which was entered into between the companies i.e. Nirma Limited, the company which issued the DDBs and the IFCL Ltd. Nirma Limited issued the certificate of holding to the assessee on 10-5-2001. This DDB Series A of Nirma Limited was listed in National Stock Exchange on 20-9- 01 and was made available for dematerialization as on 24-9-2001. Though the letter of Allotment was issued to the assessee as on 23- 09-00, the certificate of holding could be issued to the assessee as on 10-5-2001. Since the 850 DDBs of Nirma Limited had been repurchased by it, the income on the same is interest income. For the rest of the DDBs since the Letter of Allotment is different in its nature and character, the sale of this scrip can be considered to have taken place only from the date of issuance of certificate of holding, therefore, the assessee was asked to explain as to why this gain should not be considered as STCG since the assessee was given ownership of these DDB Series A of Nirma Limited on 10-5-2001 as per the terms of debenture trust deed dated 27-4-2001 and the same were sold on 19-3-2002.
On 850 DDBs of Nirma Limited, the same has been repurchased by the issuer itself and TDS of Rs.29,47,800/- has been deducted @ 20.4% on the interest income of Rs.1,44,50,000/-.
From the above transactions, it is very clear that the DDBs have been repurchased by the original issuer. Therefore as per Circular dated 15-02-2002 as well as, as per letter dated 12-05-96 of the Board, the income accruing on the same should be treated as interest income.
The assessee has shown LTCG of Rs.3,66,00,222/- on these transactions and also claimed the benefit of sec. 54EC of I.T. Act by making the investment in Rural Electrification Corporation Bonds of Rs.3,66,00,000/-. The assessee was asked to prove the genuineness -5- of claim of this gain as LTCG and the claim of benefit of Sec. 54EC of I.T. Act.
The assessee was asked to explain as to why the income generating from this transaction should not be considered as STCG income in the light of Circular 2 of 2002 of CBDT. As per the provisions of the I.T. Act, only for a listed 'security', the period of holding of long term capital asset is more than 12 months, otherwise it is more than 36 months. Since in case of he assessee, the 'security' i.e. DDB, Series-A of Nirma Limited could be listed only on 20-9-01, before this its nature is such that it cannot be considered in the definition of an asset for which the period of holding as long term capital asset is more than 12 months. Therefore there is material difference in a letter of allotment before it is listed in a stock exchange and after to the same. Moreover, the letter of allotment is not covered in the definition of the 'security' as per Act, therefore it is very different from the 'debenture certificate'.
The assessee has also purchased the DDB, Series B of Nirma Limited amounting to Rs.12,50,00,000/- as on 08-10-01, but the accrued interest has not been offered on the same, though Norma Limited has claimed the interest on the same. The assessee was also asked to explain as to why the accrued gain should be added on the same on accrual basis.
The value of a security increases in a market on day to day basis because as the time passes the maturity date nears down. In case of a secured debenture the liquidity is highly assured. Therefore, it can be safely concluded that the gain in a security accrues on annual basis even though the exp. may not accrue in the hands of the issuer of the security. In case of Nirma Group, the story is exactly opposite. Norma Limited, the issuer of DDB, Series-A has claimed the interest exp. on accrual basis, though the liability has not arisen before the maturity date and also the holder of DDBs of this Group have not offered the gain on these securities which is automatically accruing in the same because of their high liquidity and nearing down of the maturity date.
Submission of the assessee In his submission dated 10-03-05, the assessee furnished its as under:
I have received your above referred final show cause notice on 15/02/2005, requiring us to explain the issues as referred to in the notice. Some of the issues referred in the show cause notice are raised for the first time. Our para wise submissions are as under:-6-
Discount Bonds of Nirma Limited - Series-B Your goodself has referred to our investment of Rs.12.5 Crores in Deep Discount Bonds (DDB) of Nirma Limited, Series-B and required us to explain, in the light of Circular No.2 of 2002 of CBDT, as to why interest income as worked out on the basis of the present value of these bonds as on 31- 03-2002 should not be charged as interest income.
In order to understand issue comprehensively I furnish hereunder the details of investment in the said DDBs.
Date of Investment Amount paid by Cheque
Allotment Amount Cheque Date Amount drawn on
(In Lacs) No. (In Lacs)
08/10/01 1250 829649 08/10/01 1250 The
KCCB
Ltd.
I enclose herewith copy of Allotment Letter dated 12/10/01 received in respect of above investment marked Annexure-A. I request reference to press released dated March 20, 2002 issued after issue of circular No.2/2002 of CBDT referred by your goodself, wherein it is mentioned that 'It is also established principle that a circular issued by the CBDT cannot hare a retrospective tax effect. The present circular (i.e. No.2 of 2002) on deep discount bonds, therefore, specifies the tax treatment in respect of bonds which are issued after the issue of the circular, and does not seek to impose the modified tax treatment on existing bonds-holders.' Thus, in our case, since the referred investments have been made prior to issue of Circular No.2/2002 dated 15/02/02, the same is not applicable to your assessee and therefore the question of offering interest income in respect of referred investment considering circular No.2 / 2002 does not arise in your assessee's case. I request reference to clarification issued by CBDT vide letter No.225/45/96/ITA If dated 12.03.96 reported at (1996) 88 Taxman 146 (ST) wherein the tax implication of this kind of debentures has been clearly spelt out and the same is relevant. Copy of the said letter No.225/45/96-ITA-II dated 12/03/96 is enclosed herewith marked Annexure-B. -7- The said letter unambiguously defines tax treatment of DDBs, which is that on transfer of bonds before maturity to be treated as capital gains / loss if held as investment and as interest income if held till maturity. The said clarification provided that the difference between the issue price and the redemption price of DDBs would be as interest income on maturity.
In view of above, there is no requirement as to offering interest income as worked out on the basis of present value of these bonds as interest income.
(ii) to (iv) Your good office has raised certain issues on the realization of Capital gain from Investment in Deep Discount Bonds (DDB) of Nirma Ltd., w. r. t. -
(a) 850 bonds repurchased by Nirma Ltd. on 01-10-01.
(b) 1002 bonds were sold on 19-03-02.
With reference to above transaction, your good office has raised following questions:
i) In view of Circular 2 of 2002, income offered on 1900 Bonds under the Long Term Capital Gain should be taxed as interest income.
ii) TDS of Rs.29.48 lacs claimed in the return for AY 2002-
03 but corresponding income i.e. Rs.1,44,50,000/- reflected in the said certificate has not been offered as income, which is in contravention of sec. 199.
iii) Though the Letter of Allotment was given on 23-09-00 the certificates of Bonds were given on 10-05-01. The Letter of Allotment is different from certificate of Bond and both are separately tradable and therefore the period of holding for bond certificate should be counted from 10-05-01 and therefore the sale of such certificates would be a Short Term Capital Gain.
iv) Also the interest and consequential short term capital gain to be taxed as per above referred circular No.2 of 2002 and not long term capital gain.
I mention hereunder the facts of the case in brief for the quick understanding of the matter.
FACTS OF THE CASE -8- Date of clearance of cheque No.81821 of Rs.1807 lacs 28.07.2000 Date of clearance of cheque No.818215 of Rs.15 lacs Date of clearance of cheque No.818216 of Rs.30 lacs towards application for 1852 Debentures.
Date of allotment, by way of Board Resolution on 23-09- 2000 (Effective) deemed date of allotment 28-07-2000 Date of letter of allotment (Tradable and transferable) 23-09-
2000 Date of Debenture Certificate (Issue on surrender of LOA) 10-05- 2001 Date of Dematerialization 19-09- 2001 From 1852 Bonds at the opening of the AY 850 Bonds repurchased by Nirma Limited on 01-10- 2001 1002 Debentures sold on 19-03- 2002
In support of all above facts I enclose herewith the following documents.
1. Copy of Information Memorandum issued by Nirma Limited.
2. Copy of Bank Statement evidencing clearance of cheque totaling To Rs.1852 lacs on 28-07-00.
3. Copy of Board Resolution dated 23-09-2000.
4. Copy of Letter of Allotment, confirming allotment on 28-07- 2000
5. Copy of Debenture Certificate dated 10-05-01 6 Copy of Demat Account statement evidencing credit of 1852 Bonds on account of dematerialization.
-9-7. Copy of letter dated 25-05-01 for invitation for the repurchase Of DDB Series-A addressed to all debenture holders
8. Copy of letter dated 01-10-01 regarding payment for repurchase Of DDB.
9. Copy of letter dated 03-01-02 regarding TDS and repurchase of DDB.
Our submissions on the issues raised by your good office in the light of above facts.
i) Your good office has referred Circular No.2 of 2002 dated 15/02/02 and relying on the said circular, your good office is of opinion that the income should be taxed as interest income.
Without prejudice to the validity of issue of circular No.2 / 2002 of CBDT referred to by your goodself, it is stated that the same is effective from the date of issue of circular i.e. 15/02/2002 and not with retrospective effect. Since, in our case 1852 DDBs Series-A have been acquired on 28-07-2000, the circular referred by your goodself is not applicable to our case.
I request reference to para-3 of the same circular, where, in the last line it has been mentioned that "...the Board have decided that such income may hereafter be treated as follows". This is further strengthened by a press release dated March 20, 2002 issued after issue of circular No.2/2002 of CBDT referred by your goodself.
This press release was required to be given because there had been certain reports that the treatment of DDB as specified in the circular dated February 15, 2002 issued by the CBDT is anomalous, as it provides for taxation of income from such bonds on an annual basis, even though no income is received by the bond-holder before maturity. It has been opined that a heavy tax burden is being placed on persons who have been holding such Bonds for a while and a cumbersome obligation of valuing the bonds every year on the basis of Reserve Bank of India guidelines is being cast on small investors. There, in the press release in para-4 it has been clarified that "// is also established principle that a circular issued by the CBDT
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cannot have a retrospective tax effect. The present circular (Le No.2 of 2002) on deep discount bonds, therefore, specifies the tax treatment in respect of bonds which are issued after the issue of the circular, and does not seek to impose the modified tax treatment on existing bonds-holders."
Thus, in our case, since the said debentures were issued by Nirma Ltd. / acquired by us much prior to issue of Circular No.2/2002 dated 15-02-02, the same is not applicable to your assessee and therefore the question of offering interest income in respect of referred investment considering circular No.2/2002 does not arise in your assessee's case.
I request reference to clarification issued by CBDT vide letter No.225/45/96-IAT 11 dated 12-03-96 reported at (1996) 88 Taxman 146 (ST) wherein the tax implication of this kind of debentures has been clearly spelt out which is relevant to facts of our case.
Further it is submitted that as defined in sub-section 42(B) of the section 2 of the IT Act, "short term capital gain" means capital gain arising from the transfer of a short term capital assets."
As per the provision of sub-section (42 A) of section 2 of the IT Act, "short term capital asset" means capital asset held by an assessee for not more than thirty six months immediately preceding the date of its transfer.
Provided that in the case of a share held in a company or any other security listed in a recognized stock exchange in India or a unit of Unit Trust of India established under the Unit Trust of India Act 1963 (52 of 1963) or a unit of a Mutual Fund specified under clause (23D) of section 10, the provision of this clause shall have effect as if for the words "thirty six months" the words "twelve months" had been substituted.
Thus, in our case, the period of holding of capital asset namely debentures, which are listed in recognized stock exchange, had been determined as follow:
Date of Allotment - 28.07.00 - 1936 Bonds Date of Transfer - 01-10-01 for 850 Bonds purchased by the Co.
19.03.02 for 1002 Bonds sold
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As the said asset had been held for a period of more than "twelve months" it is not a short term capital asset, and in terms of provision of sub-section (29B) of section 2 of the IT Act, "long term capital asset" means a capital asset, which is not a short term capital asset and therefore, considering facts of the case and provisions of the Act, claim as long term capital gain has rightly been made by us, which may please be not disturbed.
ii) TDS on repurchase of 850 DDEs of Nirma Ltd. Series-A As regards to TDS on repurchase of 850 DDB by Nirma Ltd. I state that the Company has repurchased the same, at the price offered by Nirma Limited and paid the proceeds without deducting TDS. Subsequently y way of abundant caution, Nirma Limited opted to pay the 'TDS' after recovering from us. Since for us, it was natural transaction, i.e. I was to get credit from Government, I did not object to same. In any case the requirement of sec.199 i.e. (a) deduction is in accordance with law and (b) the person from whose Income the deduction was made, for claiming credit are fully complied, I was legally entitled for the credit. So the amount of TDS has to be given as credit to our account.
As far as income is concerned, I have offered the real income, earned by us, to tax. Nowhere in the scheme of Income-tax Act, as I understand, there is concept of taxing non-real income, based on third party TDS certificate.
As per the provisions of the Act, it is not the requirement of the law that the "corresponding amount of income" is required to be offered.
What is stated in the provision is that, any deduction made shall be treated as a payment of tax on behalf of the person from whose income the deduction was made and credit shall be given to him for the amount so deducted on the production of the certificate furnished u/s 203, in the assessment made under this Act for the assessment year for which such income is assessable.
Thus credit is to be given in the assessment year for which income is assessable and not necessarily the corresponding amount of income and under the corresponding head of the income.
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It is well settled principle of tax law that the head and nature of expenditure may be different both in the hands of the payer and the recipient. The tax has been deducted on Rs.1,44,50,000/- at Rs.29,47,800/- considering the payment as interest. Where, the same amount in the hands of recipient i.e. your assessee is included under the head capital gain. Thus claim made, being in terms of the provision of the Act, credit of TDS may kindly be granted.
Further I request your goodself to kindly intimate us regarding the provision of the Act under which you propose to add income as shown in the TDS certificate and then to give credit of TDS made.
As I understand there is no such provision and therefore proposed addition can never be made for which your assessee strongly objects to and reserve right to make further submission after getting the provisions under which your goodself intend to add and assess the income, if any.
i) Your goodself has referred to the certificate of bonds issued on 10-05-01 and stated that Letter of Allotment issued on 23- 09-00 is different from certificate of bond and both are separately tradable and therefore the period of holding the bond certificate should be counted from 10-05-01.
The Asset in question i.e. the Debentures have been acquired by your Assessee on 28-07-2000 by original subscription, which is based on the application made in pursuance to the Information Memorandum, which is a document specifying the terms, conditions, etc., of the debentures. The company issued letter of Allotment (LOA), which is tradable and transferable as evident from the back side of the LOA, further clarified by condition No.1. So far as transferability and tradability, one need not even resort to legal provisions, which are clearly permitting the same. After completion of allotment procedure and formality, in lieu of said LOA, Debenture Certificates are issued and at this in time, the right under LOA seizes and is replaced by debenture certificate. The basic right in property remain the same as LOA as for Debentures and after issue of debenture certificate only the later one survives. So it is factually incorrect to say that both are separately tradable. As given point in time there can be trading only in one only.
Issuance of debenture certificate dated 10-05-2001 is merely a procedural part and is in exchange of LOA, which gets cancelled, so underlying asset remains one and same. The asset in terms of Sec. 2 (42A) of the IT Act, which speaks
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about Asset held by the Assessee definitely comes into play from the date of allotment. The same is also demonstrated by sub-section (d) of the section, which clearly states, "the period shall be reckoned from the date of allotment of such Financial Asset".
I also reproduce hereunder Sec. 108 of the Companies Act, 1956, which is relevant for the purpose.
"Transfer not to be registered except on production of instrument of transfer.
108.(1) A company shall not register a transfer of shares in, or debentures of, the company, unless a proper instrument of transfer duly stamped and executed by or on behalf of the transferor and by or on behalf of the transferee and specifying the name, address and occupation, if any, of the transferee, has been delivered to the company alongwith the certificate relating to the shares or debentures, or if no such certificate is in existence, along with the letter of allotment of the shares or debentures."
Observation that date the period of holding the capital asset viz. Deep Discount Bonds of Nirma Ltd. Series-A should be counted from the date of issue of certificate i.e. 10/05/2001 and not from the date of allotment is factually incorrect.
From above, your good office will appreciate the fact that the underlying amount, in LOA and Debenture is same and there is no difference what so ever. Even no new asset came into picture at any point in time.
Your good office would appreciate that based on the facts, it is transparently clear that Asset in question has been acquired clearly atleast on the date at which the bond has been allotted, even if the deemed date of allotment is not being recognized by the department.
iv) Your good office has referred Circular No.2 of 2002 dated 15/02/2002 and relying on the said Circular, your good office is of opinion that the income should be taxed as interest income and consequentially short term capital gain. Though the same has been replied hereinabove in case of Debentures of Tata Finance, for the sake of brevity the same is not reproduced once again. However, in nutshell I submit that as per the press release dated 20-03-02 it has been made absolutely clear that the Circular No.2 of 2002 is applicable only in
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respect of bonds which are issued after the issue of the Circular, and does not seek to impose the modified tax treatment on existing bond holders. The Bonds under question are issued in Calendar Year 2000.
I request reference to clarification issued by CBDT vide letter No.225/45/96-ITA II dated 12-03-96 reported at (1996) 88 Taxman 146 (ST) wherein the tax implication of this kind of debentures has been clearly spelt out which is relevant to facts of our case.
Since, the assessee has earned long term capital gain, deduction u/s 54EC of the Act is available."
4.2 Background:
A search and seizure action u/s 132 of the Act was carried on 27-9-2001 in case of Nirma Group of entities. In the block assessment of the Nirma Ltd. and other entities of this concern like Nirma Chemical Works Ltd. etc., the fact has been already brought out that all the important decisions affecting the entire Group have been taken by some important persons including Shri K. K. Patel the CMD of Nirma Ltd. and the main person of entire Group. The assessee is son of CMD of Norma Ltd., i.e., Shri Karsanbhai K. Patel and is also director of Nirma Ltd. This Nirma group of entities has planned a number of transactions in such a way that the tax has been avoided at very large scale. The seized records clearly showed as to how the tax planning is carried out in case of Nirma group of entities.
4.3 The group entities of Nirma have planned the avoidance of tax by artificially converting the STCG arising out of sale of DDB, SeriesA of Nirma Ltd. into LTCG. The assessee is son of CMD of Nirma Ltd. and is also director of Norma Ltd., which is flagship concern of this Nirma Group of entities. The planning involves deeming of date of acquisition of DDB, Series-A of Nirma Ltd. almost one year prior to the date of actual issue of certificate of bond. As Nirma Ltd. is part of this group, it willingly took out the certificate of DDB on 10-
5-2001 with a note in this certificate that the deemed date of allotment would be 28-07-00. This deeming provision was incorporated to help the Nirma group of entities to artificially increase their period of holding of DDB series-A certificate by more than one year which they had actually held from May, 2001 to March, 2002 (i.e. less than one year).
4.4 Facts of the present case:
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The assessee is son of CMD of Nirma Ltd., i.e., Shri Karsanbhai K.Patel. He is also the director of the Nirma Ltd. From the facts of the case mentioned above it has been found that the assessee has not offered the interest income on the DDBs repurchased by the assessee company though in the above submission he has clearly brought out into the light the provisions of the law as per letter of the Board dated 12-03-96 and the Circular dated 15-02-02. This means that the assessee has avoided the tax clearly knowing all the provisions of the law.
4.5 Circular No.2 of 2002 & Letter No.225 dated 12-3-1996 of CBDT:
It will be relevant here to discuss the provisions of Circular No.2 of 2002 of CBDT dated 15-2-2002. This circular is produced as under:
"A review of the tax treatment of income arising from Deep Discount Bonds has been under consideration in the Board for some time. The Board had earlier clarified by way of certain letters issued to the Reserve Bank of India and others that the difference between the bid price (subscription price) and the redemption price (face value) of such bonds will be treated as interest income assessable under the Income-tax Act. On transfer of the bonds before maturity, the difference between the sale consideration and the cost of acquisition would be taxed as income from capital gains where the bonds were held as investment, and as business income where the bonds were held as trading assets. On final redemption, however, no capital gains will arise. It was further clarified that tax would be deducted at source on the difference between the bid price and the redemption price at the tie of maturity.
2 Such tax treatment of Deep Discount Bonds, however, has posed the following problems:
(i) Taxing the entire income received from such a bond in the year of redemption as interest income gives rise to a sudden and huge tax liability in one year whereas the value of the bond has been progressively increasing over the period of holding.
(ii) Where the bond is redeemed by a person other than the original subscriber, such person becomes taxable on the
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entire difference between the bid price and the redemption price as interest income, since he is not able to deduct his cost of acquisition from such income.
(iii) A company issuing such bonds and following the mercantile system of accounting may evolve a system for accounting of annual accrual of the liability in respect of such a bond and claim a deduction in its assessment for each year even though the corresponding income in the hands of the investor would be taxed only at the time of maturity.
(iv) Taxing the entire income only at the time of maturity amounts to a tax deferral.
3 The matter has now been examined in consultation with the Reserve Bank of India and the Ministry of Law. The practice followed in several countries outside India has also been examined. With a view to remove the anomalies in the existing system of taxation of income from Deep Discount Bonds, and to formulate a system which is more in line with international practice, the Board have decided that such income may hereafter be treated as follows.
4 General Treatment:
Every person holding a Deep Discount Bond will make a market valuation of the bond as on the 31 s t March of each Financial Year (hereafter referred to as the valuation date) and mark such bond to such market value in accordance with the guidelines issued by Reserve Bank of India for valuation of investments. For this purpose, market values of different instruments declared by the Reserve Bank of India or by the Primary Dealers Association of India jointly with the Fixed Income Money Market and Derivatives Association of India may be referred to.
4.1 The difference between the market valuations as on two successive valuation dates will represent the accretion to the value of the bond during the relevant financial year and will be taxable as interest income (where the bonds are held as investments) or business income (where the bonds are held as trading assets).
4.2 In a case where the bond is acquired during the year by an intermediate purchaser (a person who has acquired the bond by purchase during the term of the bond and not as original
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subscription) the difference between the market value as on the valuation date and the cost for which he acquired the bond, will be taxed as interest income or business income, as the case may be, and no capital gains will arise as there would be no transfer of the bond on the valuation date.
5. Transfer before maturity:
Where the bond is transferred at any time before the maturity date, the difference between the sale price and the cost of the bond will be taxable as capital gains in the hands of an investor or as business income in the hands of a trader. For computing such gains, the cost of the bond will be taken to be the aggregate of the cost for which the bond was acquired by the transferor and the income, if any, already offered to tax by such transferor (in accordance with para 4 above) upto the date of transfer.
5.1 Since the income chargeable in this case is only the accretion to the value of the bond over a specific period, for the purposes of computing capital gains, the period of holding in such cases will be reckoned from the date of purchase / subscription, or the last valuation date in respect of which the transferor has offered income to tax, whichever is later. Since such period would always be less than one year, the capital gains will be chargeable to tax as short-term capital gains.
6. Redemption:
Where the bond is redeemed by the original subscriber, the difference between the redemption price and the value as on the last valuation date immediately preceding the maturity date will be taxed as interest income in the case of investors, or business income in the case of traders.
6.1 Where the bond is redeemed by an intermediate purchaser, the difference between the redemption price and the cost of the bond to such purchaser will be taxable as interest or business income, as the case may be. For this purpose, again, the cost of the bond will mean the aggregate of the cost at which the bonds were acquired and the income arising from the bond which has already been offered to tax by the person redeeming the bond.
7. STRIPS Apart from original issue of Deep Discount Bonds, such bonds can also be created by "stripping", i.e. the process of
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detaching the interest coupons from a normal coupon bearing bond and treating the difference coupons and the stripped bond as separate instruments or securities ("strips") capable of being traded in independently. Such a mechanism, referred to as STRIPS (Separate Trading of Registered Interest and Principal of Securities) creates instruments which are in the nature of Deep Discount or Zero Coupons Bonds from out of the normal interest bearing bonds. Accordingly, the tax treatment of the different components of principal and interest created by such stripping will be on the same lines as clarified in the preceding paragraphs in respect of Deep Discount Bonds.
7.1 The process of stripping of a normal interest-bearing bond into its various components will not amount to a transfer within the meaning of the Income-tax Act as it merely involves the conversion of the unstripped bond into the corresponding series of STRIPS. Similarly, the reconstitution of STRIPS to for a coupon bearing bond will not amount to a transfer.
8. Tax deduction at source:
The difference between the bid price of a deep discount bond and its redemption price, which is actually paid at the time of maturity, will continue to be subject to tax deduction at source under section 193 of the Income-tax Act. Under the existing provisions of that section, no tax is deductible at source on interest payable on Government securities. Further, the Central Government is empowered to specify any such bonds issued by an institution, authority, public sector company or cooperative society by way of notification, exempting them from the requirement of tax deduction at source.
9. Option to investors:
Considering the difficulties which might be faced by small non-corporate investors in determining market values under the RBI guidelines and computing income taxable in each year of holding, it has further been decided that such investors holding Deep Discount Bonds upto an aggregate face value of rupees one lakh may, at their option, continue to offer income for tax in accordance with the earlier clarifications issued by the Board referred to in para 1 above.
10. The contents of this Circular may be brought to the notice of all the officers working in your region."
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From the above provisions of this circular, it is very clear that the Central Board of Direct Taxes has given detailed instructions on the manner in which the accrued interest / STCG has to be calculated on the income accruing and arising from the DDB. This Circular 2 of 2002 clarifies the letter F.No.225/45/96-IT.II dated 12-3-1996.
It is clarified that the difference between the issue price and redemption price of DDBs will be treated as interest income assessable under the Income-tax Act. On transfer of Bonds before maturity the difference between the sale consideration and issue price will be treated as capital gains / losses if the assessee purchased them by way of investment. However, in the case of an assessee who deals in purchase and sale of bonds, securities, etc. the profit or loss shall be treated as trading profit or loss.
From the above provision of Circular No.2 of 2002 and this letter F.No.225 dated 12-3-1996 it is clear that the Board tried to tax the income accruing and arising from the transaction of DDBs. In the letter dated 12-3-1996 nothing has been said about long term or short term treatment of the gains arising from the transactions of these DDBs. This obscure / grey area has been covered in the circular dated 15-2-2002.
PIB Press Release of CBDT dated 20-3-2002 The assessee has relied on the PIB Press release of CBDT, dated 20-03-02, therefore it will be relevant to produce the same, this is produced as under:
"TAX TREATMENT OF DEEP DISCOUNT BONDS AND STRIPS.
PIB Press Release, dated March 20, 2002.
There have been certain reports in the press recently suggesting that the tax treatment of deep discount bonds as specified in the Circular dated 15-02-02 published at (2002) 173 CTR (St.) 217] issued by the Central Board of Direct Taxes is anomalous, as it provides for taxation of income from such bonds on an annual basis, even though no income is received by the bond-holder before maturity. It has been opined that a heavy tax burden is being placed on persons who have been holding such bonds for a while, and a cumbersome obligation of valuing the bonds every year on the basis of RBI guidelines is being cast on small investors, the reports are misconceived and based on an incorrect understanding and
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inadequate knowledge of facts and law. The modified tax treatment now specified fact corrects the anomalies in the existing system by providing a mechanism for taxing income accruing from year to year on deep discount bonds, on the same lines as income from normal coupon bearing bonds is taxed. Transfer of the bonds before maturity will attract capital gains tax, as in the existing system.
The earlier system of taxing the entire income received from such bonds in the year of redemption as interest income was anomalous in that it gave rise to a sudden and huge tax liability in one year whereas the value of the bond had been progressively increasing over the period of holding. Further, where the bond was redeemed by a person other than the original subscriber, such person was taxed on the entire difference between the bid price and the redemption price as interest income. Such a system also created tax-induced distortions in the debt market, and was an impediment to the development of a market in STRIPS, which are essentially zero coupon instruments derived from normal coupon bearing bonds.
Taxation of income on accrual basis is an established principle of law, and always results in taxing income that has not yet been received. Income from deep discount bonds accrues continuously over the period of holding and can be realized at any time by selling the bond. Taxing income from such bonds on accrual basis annually is, in fact, a practice followed world-wide.
It is also an established principle that a circular issued by CBDT can not have a retrospective tax effect. The present circular on deep discount bonds, therefore, specifies the tax treatment in respect of bonds which are issued after the issue of the circular, and does not seek to impose the modified treatment on existing bondholders. Further, non- corporate persons who invest small amounts in new issues (face value upto Rs.l lakh) can still opt for the old system.
Valuing the bonds every year on the basis of RBI guidelines will not pose any problem as such values can be obtained from the issuers themselves, who will invariably be the RBI or a public financial institution. The amount received on redemption would always be liable to tax deduction at source as per normal provisions of the Income-tax Act. However, no TDS is required on interest payable on Government securities and bonds issued by an institution, authority, public sector company or cooperative society can also be exempted from the requirement by notification.
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The purpose of this press release is to make it clear that no heavy burden of tax is being cast upon the holders of the bonds and also that the small investors need not worry or get panicked from such provisions which are very scientific and prevalent worldwide. It has been reemphasized that the modified tax treatment will correct all the anomalies of the existing system. This has also made it clear that there will be no sudden and huge tax liability and the last bond holder will not be liable to entire tax liability. This release has expressed that the accrual system of accounting is established principle of law and is adopted world wide. It is reassuring that the valuation will not pose any problem since the same can be obtained from the issuers and mandated that the TDS will be done on every redemption.
The assessee has claimed that this press release has given the clean chit to it that the existing bond holders can adopt the old system. But old system no where provides for the double treatment of the accrual of the expense/income. On the one hand the same management has adopted the accrual of exp. in the hands of Nirma Ltd. on annual basis and the same management is adopting the second standard for accrual of income by taking recourse of the earlier letter. This shows the deliberate planning and tax avoidance by the same group by forming the holding companies the basic purpose of which is to invest in the shares of *he flagship company Nirma Ltd. and claim the exp. on annual basis and not to offer the income on the hand of the folders of these bonds.
4.7 Macro-view of entire Group clarifies the planning to avoid tax:
From the balance sheet of A.Y.2001-02 & A.Y. 2002-03 of Nirma Ltd., it has been found that it is a very cash rich company. It has a general reserve of Rs.743.05. This is a high profit earning company. It has extended loans and advances of Rs.224.26 crores. But still it has issued the DDB, Series-A of Rs.350 crores and DDB Series B of Rs.100 crores. It has also been found from the details called for that all these DDB, Series-A and Series-B have been issued to only the persons belonging to Nirma Group. It is striking to note that out of 35000 DDBs Series A of Nirma Ltd, 11045 have been issued to Shri K.K. Patel, CMD, Shri Rakesh Patel, his son and Director, Shri Hiren K. Patei again his son and director and Shantaben K. Patel his wife. Similarly out of total 10000 DDB, Series B of Nirma Ltd., 2500 has been issued to Shri Hiren K. Patel and Shri Rakesh K. Patel again the directors. It is very strange to observe that, when the option of taking loans and advances from these persons was available with Nirma Ltd., why did this company issued these DDBs, which bear a cost of security also. In the balance sheet the unsecured loans pertaining to DD3, Series-A have been shown at Rs.525 crores and for DDB Series-B of Rs.115.50 Crores. The
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interest has been claimed on these on annual accrual basis. But in the hands of the holders of these DDBs no interest has been shown on the accrual basis even though they are adopting the mercantile system of accounting. The same management has interpreted the law in case of Nirma Ltd. that the exp. can be claimed on accrual basis, but the income has not been offered on accrual basis. Though the situation is exactly opposite, the value of a security increases in a market on day to day basis because as the time passes the" maturity date nears down. In case of a secured debenture the liquidity is highly assured. Therefore it can be safely concluded that the gain in a security accrues on annual basis even though the exp. may not accrue in the hands of the issuer of the security. In case of Nirma Group, the exactly opposite has been done. Nirma Ltd., the issuer of DDB, Series-A has claimed the interest exp. on accrual basis, though the liability has not arisen before the maturity date the holders of DDBs of this Group have not offered the gain on these securities wh.v~h is automatically accruing in the same because of their high liquidity and nearing down of the maturity date.
4.8 The reliance in this regard is placed in the decision of Gujrat High Court in the case of CIT vs. Sakarlal Balabhai (1968) 69ITR186, this was later on approved by Hon'ble Supreme Court in 86ITR2. In this it has been stated that the tax avoidance postulates that the assessee is in receipt of the amount which is really and in truth his income liable to tax but on which he avoids payment of tax by some artifice or device. Such artifice or device may apparently show the income as accruing to another person at the same time making it available for use and enjoyment to the assessee or mask the character of the income by disguising it as a capital receipts. It is wrong to encourage or entertain the belief that it is hon'ble to avoid the payment of tax by resulting to dubious methods and subterfuges. The above pronouncements of Courts have been discussed elaborately in case of Mcdowell & Co. Ltd. Vs CTO 154 ITR 148. The view of the Hon'ble SC is produced as under'.
"We may also recall the observations of Viscount Simon in Latilla v. IRC [1943] 25 TC 107 (HL), p. 117:
Of recent years much ingenuity has been expended in certain quarters in attempting to devise methods of disposition of income by which those who were prepared to adopt them might enjoy the benefits of residence in this country while receiving the equivalent of such income, without sharing in the appropriate burden of British taxation, judicial dicta may be cited which point out that, however elaborate and artificial such methods may be, those who adopt them are 'entitled' to do so. There is, of course, no doubt that they are within their legal rights, but that is no reason why their efforts, or those of the professional gentlemen who assist them in the matter,
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should' be regarded as a commendable exercise of ingenuity or as a discharge of the duties of good citizenship. On the contrary, one result of such methods, if they, succeed, is, of course, to increase Protanto the load of tax on the shoulders of the great body of good citizens who do not desire, or do not know how, to adopt these manoeuvres. Another consequence is that the Legislature had made amendments to our Income-tax Code which aim at nullifying the effectiveness of such schemes.
Tax planning may be legitimate provided it is within the framework of law. Colourable devices cannot be part of tax planning and it is wrong to encourage or entertain the belief that it is honourable to avoid the payment of tax by resorting to dubious methods. It is the obligation of every citizen to pay the taxes honestly without resorting to subterfuges."
4.9 The Nirma group has tried to interpret the section 37(1) in such a way that the claim of interest on these DDBs is available to Nirma Ltd. on accrual basis but in case of the holders of the DDBs the same group has interpreted the letter of Board dated 12-3-1996, Circular of the Board dated 15-2-2002 and Press release dated 20-3- 2002 in different manner. In this regard, the reliance is placed in case of CWS(India) Ltd. Vs. CIT 208 ITR 649 in which it has been observed that when a literal interpretation leads to an absurd or unintended result, even the language of the statute can be modified to accord with the intent of legislation and to avoid absurdity. In the case of Indian Hotels Ltd. vs. ITO 245 ITR (SC) a similar view has been affirmed. In the case of Govindan (K) and Sons vs. CIT 247 ITR 192 and Oxford University Press vs. CIT 247 ITR 658, the Hon'ble SC has held that interpretation must avoid absurdly and if literal construction leads to unreasonable or absurd consequences, the same should not be adopted.
4.10 The reliance is also placed in Circular No. 783 dated 18-11- 1999 of Central Board of Direct Taxes in which a clarification relating to waiver of interest u/s. 234A, 234B, 234C has been made. From this circular it is clear that when a press release leads to unintended results or if the provisions of a press release are not coherent and are contradictory, these provisions did not prevail. The same is produced as under:
"The Board by an order (vide f.No. 400/234/95-IT(B)), dated 23-5-1966, indicated the class of income or class of cases in which reduction or waiver of interest u/s. 234A, 234B and 234C would be considered by the Chief CIT and DGIT. Prior to the issue of the order a press note was released on 21-5- 1996, -with a view to give wide publicity to the major step
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contemplated by the Board towards mitigating hardship in genuine cases.
However, the instances have come to the notice of the Board where certain claims have been made on the basis of Para- 2(v) of the press note seeking waiver of interest for non- payment of advance tax. Para-2(e) of the order dated 23-5- 1996, contains no such stipulation. It is hereby clarified that making any claim for waiver of interest based on the press note dated 21-5-1996 is not sustainable. A press note is basically intended to give a bond idea in advance to the public at large regarding policy / step under formulation. To treat a press note as a final legal document and to make any claim on the basis of it as against the contents of the final document is not maintainable.
The Board hereby reiterates that all requests for waiver of interest are to be considered by the Chief CIT and the DGIT within the parameters laid down by the Board's order dated 23-5-1996 read with the order dated 30-1-197. "
From the above Circular, though it does not relate with the claim of interest and accrual of interest income/STCG on DDBs, it is very clear that when a press release and a Circular lead to unintended results or if the provisions of a press release are not coherent and are contradictory, the provisions of Circular prevail. It is again clarified that in the letter dated 12-3-1996 there was no mention of short term or long term accrual of income. The grey areas were covered by circular dated 15.02.02. But Nirma group, before issuance of the circular dated 15.02.02 interpreted the law in such a way that the interest expense has been chimed on accrual basis in the hands of Nirma Ltd., then it was obligatory in it to apply ihe same interpretation in case of holders of DDBs in case of accrual of exp. and income. The clarification in this regard emerges from the provisions of Circular dated 15-2-2002. And for the sake of coherency again, no resort of press release dated 20-3-2002 should be taken by it.
4.11 Intention of Legislature supports the clarification of the Board:
Here it will be relevant to discuss the intention of the legislature about taxing the interest accruing on the securities. For this purpose the sec.145 of I.T. Act is very important. In the relevant year this section is as under:
145. Method of accounting.
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(1) Income chargeable under the head "Profits and gains of business or profession" or "Income from other sources" shall, subject to the provisions of sub-section (2), be computed in accordance with either cash or mercantile system of accounting regularly employed by the assessee.
(2) The Central Government may notify in the Official Gazette from time to time accounting standards to be followed by any class of assessees or in respect of any class of income.
(3) Where the Assessing Officer is not satisfied about the correctness or of the accounts of the assessee, or where the method of accounting provided in sub-section (1) or accounting standards as notified under sub-section (2), have not been regularly followed by the assessee, the Assessing Officer may make an assessment in the manner provided in section 144.
From the above it is crystal clear that the legislature has made it mandatory on assessee to adopt the regularly employed method of accounting. As has been observed above the assessee is bound to employ the mercantile system of accounting this year. Therefore the interest on these DDBs automatically accrues. Even if the assessee tries to change the same this year, he can not do the same, since the undersigned can not permit him to do so. In this regard to understand the intention of the legislature it will be relevant to produce the provisions of the Act which were amended by Finance Act 1995 w.e.f. 01.04.1997, before this amendment, there were two provisos, these are produced as under'.
Provided further that where no method of accounting is regularly employed by the assessee, any income by way of interest on securities shall be chargeable to tax as the income of the previous year in which such interest is due to the assessee.
Provided also that nothing contained in this section shall preclude an assessee from being charged to income tax in respect of any interest on the securities received by him in a previous vear if such interest had not been charged to income tax for any earlier previous year.
The above provision of the provisos very clearly mention that the legislature was much concerned about the taxation of the interest accruing on the securities. This has categorically provided that the interest on these securities has to be charged on accrual basis if the assessee does not employ the regular method of accounting meaning thereby if the assessee takes the resort of some planning to avoid tax
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or postpone tax on these securities by changing the method of accounting.
Now when the assessee employs the mercantile system of accounting, at the end of the year, the interest on the DDBs automatically accrues as per the relevant provisions of sec.145, because the assessee can recover the accrual value of interest by selling such bonds. However, the gain in selling may be more or less than the accrued interest as calculated on the basis of issue price, maturity value and period of bond. The current value of bond depends on the current prime lending rate and not on the interest rate at which the maturity value of the bond was calculated at the time of issue. The circular 2 of 2002 of Board has followed the method of discounted value of maturity value of bonds at present prime lending rate and the accrued income has to be determined accordingly. Therefore, this contention of the assessee is not correct that there is no income which has accrued. The increase in market value of the security is determined by the method of discounted maturity value on 31 s t March, this is in fact the accrued income during the year in accordance with the prevailing market conditions.
It will be relevant to discuss here the provision of section 94(2) and section 94(3) of the Act. The relevant portion of this section is produced as under:
It will be relevant to discuss here the provision of section 94(2) and section 94(3) of the Act. The relevant portion of this section is produced as under
94.Avoidance of tax by certain transactions in securities.
........ (2) Where any person has had at any time during any previous year any beneficial interest in any securities, and the result of any transaction relating to such securities or the income thereof is that, in respect of such securities within such year, either no income is received by him or the income received by him is less than the sum to which the income would have amounted if the income from such securities had accrued from day to day and been apportioned accordingly, then the income from such securities for such year shall be deemed to be the income of such person.
(3) The provisions of sub-section (1) or sub-section (2) shall not apply if the owner, or the person who has had a beneficial interest in the securities, as the case may be, proves to the satisfaction of the Assessing Officer-
(a) that there has been no avoidancp of income-tax, or
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(b) that the avoidance of income-tax was exceptional and not systematic and that there was not in his case in any of the three preceding years any avoidance of income-tax by a transaction of the. nature referred to in sub-section (1) or sub- section (2).
In subsection (2) of this section, this has been provisioned that if the result of any transaction relating to such securities is that the income received by the assessee is less than the sum to which the income would have amounted if the income from such securities had accrued from day to day and been apportioned accordingly, then this provision may be invoked. In this section, the intention of legislature is clear that the assessee can not resort to such tricks by which it can avoid the tax. Here in this section the income obviously means and includes the 'nature of income' also. No income can exist without its 'nature'. The 'nature' of any income is basic characteristic which is essentially associated with its existence. There can be no income without its 'nature'. The assessee has resorted to such means by which it has tried to change the 'nature of income', and thus avoided the tax, as to which would have been liability of the assessee. From this section it is clear that the intention of legislature has always been to tax the interest accruing bonds on annual basis because if the assessee sells a bond and shows the LTCG on the same it will be nothing but the avoidance of the tax by taking the benefit of less tax rate. By not accruing the interest at 31 s t of March and then not showing the STCG for the rest of the period, the assessee has changed the nature of income and avoided the tax. The same intention of legislature has been clarified in Circular 2 of 2002 by the Board.
For better understanding of the intention of the legislature, it is relevant to discuss the provisions of current finance bill which was presented on 28-2-2005 in the Parliament. This bill has provided that the claim of deduction on 'prorata' 'discount' on the 'zero coupon bonds' shall be allowed. In sec. 36 of the Act, in sub sec. (1), after clause (iii), the following clause (iiia) shall be inserted w. e. f. 01.03.06:
(iiia) the prorata amount of discount on a 'zero coupon bond' having regard to the 'period of life of such bond calculated in the manner as may be prescribed. ~ Explanation:- For the purpose of this clause, the exprejfions-
(i) "discount" means the difference between the amount received or receivable by the infrastructure capital company or infrastructure capital fund or public sector company issuing the bond and the amount payable by such company or
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fund or public sector company on maturity or redemption of such bond.
(ii) 'period of life of the bond' means the period commencing from the date of issue of the bond and ending on the date of the maturity or redemption of such bond.
(iii) 'Infrastructure capital Company' and' infrastructure capital fund' shall have the same meanings respectively assigned to them in clauses (a) and 9b) of Explanation 1 to clause (23G) of section 10.
The " zero coupon bonds' have been defined in section 2(48) as under-
"(48) "Zero Coupon Bond" means a bond-
(a) issued by any infrastructure capital company or infrastructure capital fund or public sector company on or after the 1 s t day of June, 2005;
(b) in respect of which no payment and benefit is received or receivable before the maturity or redemption from infrastructure capital company or infrastructure capital fund or public sector company; and
(c) which the Central Govt. may, by notification in the Official Gazette, specify in this behalf. "
In section 112 of the Act, in subsection (1), in the proviso occurring below clause (d) after the words 'being listed securities or unit 1 the words 'or zero coupon bonds' shall be inserted w.e.f. 01.03.06. The effect of this is that the 'zero coupon bonds' shall be considered as long term assets if these are held more than twelve months.
It has also been proposed to amend the section 194A so as to provide that no tax will be deducted at source in respect of income payable on zero coupon bonds.
The cumulative effect of all these provisions is that only the holders of DDBs of infrastructure companies/funds or public sector companies can claim the capital gain as long term capital gain in respect of such bonds which are issued after 1-6-2005. And at the same time the company as is issuing these bonds can claim the discount each year on pro rata basis.
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Hence, the legislature always prohibited the treatment of sale of DDBs as long term capital gain. This concession has now been made available to the 'Zero Coupon Bonds' of only infrastructure companies/funds and public sector companies for bonds issued after 1-6-2005 from A.Y. 2006-07 only. No such concession is therefore available on DDB of Nirma Ltd. issued on F.Y.1999-00 since Nirma Ltd. is neither an 'Infrastructure Company' , 'Infrastructure Fund' or a 'Public Sector Company, nor the bonds were issued after 1-4-2005.
5. Preponement of date of purchase of DDBs Series A of Nirma Ltd.
From the details furnished by the assessee it was found that this DDB Series A of Nirma Ltd. was result of the terms of the Debenture Trust Deed dated 27-4-2001, which was entered into between the companies i.e. Nirma Ltd., the company which issued the DDBs and the IFCI Ltd. as trustee. Nirma Ltd. issued the certificate of holding to the assessee on 10-5-2001. This DDB Series A of Nirma Ltd. was listed in National Stock Exchange on 2-f- IM/and was made available for dematerialization as on 24-9-2001. Though the letter of Allotment was issued to the assessee earlier, the certificate of holding could be issued to the assessee as on 10-5- 2001. Since the Letter of Allotment is different in its nature and character, the sale of this scrip can be considered to have taken place only from the date of issuance of certificate of holding, therefore, the assessee was asked to explain as to why this gain should not be considered as STCG since the assessee was given ownership of these DDB Series A of Nirma Ltd. on 10-5-2001 as per the terms of debenture trust deed dated 27-4-2001.
5.1 Debenture Certificate dated 10-5-2001 different from letter of allotments dated 23-9-2000:
The assessee's submission dated 10-3-2005 has been produced above. The contentions of the assessee are not tenable. The letter of allotment is different in its nature and character from the debenture certificate. The letter of allotment is separately tradable in the market. As per the definition of 'short term capital asset', for the letter of allotment, the period of holding is 36 months, however, in case of a security which is listed in recognized Stock Exchange, this period is 12 months as per the provisions of the Act. The letter of allotment is not emanating out of the main trust deed between Nirma Ltd. and IFCI, which was in case of debenture certificate. In the Bond certificate issued by Nirma Ltd. to the assessee company dated 10-5-2001, it is very clear that these Bond certificates are issued in terms of debenture trust deed dated 27-4-2001. The relevant portion of this certificate is produced as under:
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"These DDE series - A are issued in terms of the Debenture Trust Deed dated 2 7-4-2001 (hereinafter referred to as "the Trust Deed) entered into between the company and IFCI Limited as Trustees ' Hereinafter referred to as "the Trustees ") and are secured in the manner mentioned in the said Trust Deed.......................................... Given at Ahmedabad under the Common Seal of the CompanyAs 10 t h May, 2001."
5.2 Provisions of debenture Trust deed dated 27-4-2001 From the careful perusal of the provisions of debenture trust deed dated 27-4-2001, it was found that the debenture certificate issued dated 10-5-2001 was based on this trust deed. In Clause-8.& 9 of this trust deed, it has been clarified that the DDBs Series-A have been secured by IFCI as per this trust deed. This security is the main feature of these DDBs, in absence of which the nature and character of these DDBs is not determined. These clauses are produced as under:
" Clause-8: The repayment / reduction of the principal amount DDE Series A together with other monies due in respect thereof, payment of interest, remuneration of the trustees and all costs charges expenses and other monies payable by the Company in respect of the DDE Series A shall be secured by way of pari passu first mortgage and charge in favour of the Trustees on the Bhavnagar Complex Property only of the Company such mortgage and charge shall rank pari passu with the mortgages and charges created to be created on the said immovable and movable properties in respect of the Bhavnagar Complex Properties of the Company both present and future in favour of IFCI as the Trustees of the NCD Series-A. NCD Series-B. NCD Series-C as well as towards the term loans sanctioned / to be sanctioned to the Company by the Banks and other Term Lenders / Institutions and the further borrowings of the company.
Clause-9: The company proposes to constitute, issue and secure the said DDB Series - A together with interest, remuneration of Trustees and all costs, charges, expenses and all other monies payable in respect thereof, inter alia by way of a first mortgage and charge on the Bhavnagar Complex Property created hereunder and anking pari passu with the mortgage and charges created in favour of IFCI in their capacity as Trustees for holders of NCD Series-A, NCD Series-B and NCD Series-C holders.
In section-2 of this Debenture Trust Deed, it has been very categorically stated that these debentures are constituted and issued
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as per this trust deed. The terms and conditions of the issuance are also defined in this section. This section-2 is produced as under:
"The DDB Series-A constituted and issued hereunder are 35000. Secured redeemable DDBs Series-A of a face value of Rs.1,50,000 issued at a price of Rs.1,00,000 (hereinafter referred to as DDB Series-A) aggregating to Rs.3.50 Crores.
The company covenants with the trustees that it shall pay to the DDB Series-A holders, the principle amount of the DDB Series- A on the dates mentioned in the Financial Covenants and Conditions mentioned in the Third Schedule written hereunder, and shall also pay interest (inclusive of compound interest, where applicable) on the DDB Series-A in accordance with the Financial Covenants and Conditions and the terms of issue of the said DDB Series-A. All interest on the DDE Series-A for the time being unpaid (other than unclaimed) shall carry father interest at the rate of 12.25% or as specified in the Financial Covenants and Conditions or such other rate as may be prescribed, computed from the respective due dates and shall become payable upon the footing of the compound interest with rest taken yearly.
The company shall make payments as aforesaid to or to the order of or for the account of the DDE Series - A holders and such payment shall be deemed to be in protanto satisfaction of the aforesaid covenant of the company to make such payments to the DDE Series-A holders.
In case of default in payment of principal amount of the DDE Series-A, interest and all other monies on their respective due dates, the Company shall pay on the defaulted amounts, liquidated damages at the rate of 2% p.a. for the period of default."
From these provisions of debenture trust deed dated 27-4- 2001, it is very clear that the nature and character of the articles (DDBs) under consideration which were transferred to the holders was defined and determined only as per this trust deed.
5.3. Provisions of Sales of Goods Act 1930 As per Chapter-3, of Sales of Goods Act 1930 the conditions of transfer of property between seller and buyer are given. As per section 18 of this Act it has been provided that, where there is a contract for the sale of the unascertained goods the property in the goods is not transferred. The relevant section is produced as under:
"Transfer of property as between seller and buyer"
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18. Goods must be ascertained. -Where there is a contract for the sale of unascertained goods, no property in the goods is transferred to the buyer unless and until the goods are ascertained."
As has been discussed above, the nature and character of the bonds could be determined only after debenture trust deed issued dated 27- 4-2001, therefore, these bonds can not be transferred before this date. Hence, the contention of the assessee that the letter of allotment should be considered as date of transfer is not accepted.
5.4 The assessee had relied in sub-section-(d) of Section 2(42A) of IT. Act, but this sub-section deals with the rights shares, therefore, the contention of the assessee is not accepted. It is relevant to mention here that in section 2(42A), the date of transfer in case of general debentures has not been dealt with. Though in case of right shares and bonus shares, it has been made clear that the date of allotment should be considered as date of transfer but the situation in the case of fresh issuance is different from the right shares and bonus shares, because in case of right bonus shares the nature and character of the articles under consideration (Bonus shares, right shares) is well defined. The nature of the bonus shares and the right shares is identical in nature to the main shares, already issued by the company, therefore there is no need to separately identify and record the terms and conditions in these cases. This again, makes this contention strong that in case of issuance of fresh debentures or bonds the legislature did not intend to consider the date of allotment as the date of transfer of the property in the assets (DDBs) because otherwise the legislature had also introduced these provisions in the Act. Further, a bond can be called a long term asset only when it is held for more than one year and it is listed in a recognized stock exchange as per section 2(42A) of IT. Act. In this case if the period of holding is counted from the date of listing in National Stock Exchange to the date of sale, the same is less than 12 months, therefore period of holding of these assets in no way can be considered to fulfill the condition of recognizing these as long term capital assets.
5.5 The assessee has relied on section 108 of Companies Act, 1956, but that is not relevant at all since the same deals with the production of instrument of transfer and it has been provisioned that the company shall not register transfer of shares or debentures except on production of proper instrument of transfer. It has been facilitated that if such certificate is not in existence then the letter of allotment may be considered as a valid document for affecting the transfer in the registers of the company. This is again very important to note here that the Company Act has provisioned for the
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registering of the transfer only when the certificates have been issued. The Company Act has provided the remedy when the certificate is lost by some one. This remedy can never give the letter of allotment the same legal status as is that of certificate of debenture before the very issuance of the same. It is also noteworthy that as per section 75 of Companies Act, 1956, the allotments of the debentures can be returned but the same can not be done once the debenture certificates are issued by the company.
5.6 During the hearing given to the representative of the assessee it has been argued that the execution of the trust deed is o contractual obligation as per the terms of offer and merely a formality and the procedure part of the legal terms of offer. His submission is produced as under:
"The capital asset which has been sold by your assessee is a debenture. Debenture per se is a bundle of rights, which are contracted as per the terms of the issue. The debenture is an intangible asset. Certificate is only a representation of holding of debenture. The right in debenture are acquired immediately upon allotment of the same by the Board and the name is entered in the register of debenture holders. It is a form or a shape is given to the substance. The same has come into existence, the moment it is allotted and not at the time when a shape is given to the substance 'the debenture' in the form of a certificate.
............... In this regard, over and above the submission made hereinabove, further, it is submitted that the execution of Trust Deed is a contractual obligation as per the terms of offer and is merely a formality and the procedure part of the legal terms of offer. The same can not determine the date of acquisition of asset which is debenture, the date of acquisition of the asset is the date of allotment i.e. date when the investor is vested with the rights in the capital asset, which is 28-7- 2000 in the present case and the date of execution of the trust deed i.e. 27-4-2001 is merely a procedural formality and can not determine the date of allotment. We also request reference to our reply in Para-3 hereinabove wherein we have clearly stated that a substance i.e. the date when the asset comes into the existence which is the date of allotment which only is to be considered for determining the period of holding of debenture and not the form i.e. the date when the debenture certificate are issued or the debenture trust deed is executed."
The above contentions of the assessee are not tenable. The observation of the assessee that debenture per se is a bundle of rights is correct but the final nature and character of these
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debentures has emerged only after signing of debenture trust deed dated 27-4-2001. All the terms and conditions of this transaction could not be decided at the time of allotment of these debentures because their very nature was not known. As per section 84 of Companies Act, 1956, only a certificate under the commons seal of the company shall be prima facie evidence of the title of the member on such shares. This is a certificate of transfer of title and before issuance of this the transfer can not be complete. The debenture trust deed is not merely a formality and procedure part of the legal terms of offer. This is a basic document based on which these debentures have got the credibility and tradability in the market. If these debentures had not been secured by an institution like IFCI, these would have not got that much value and liquidity as was available to these. Since, the basic character of these debentures could be finally decided by this debenture trust deed dated 27-4- 2001, their transaction could not be pre-poned before this date. Further the basic condition of a capital asset, being a long term capital asset, if it is held more than 12 months, is that it must be listed in a recognized stock exchange. The DDB, series-A was listed in National Stock Exchange only on 20-9-01). Therefore, from this date till the date of sale, the period of holding is less than one year. Hence this asset can not be said as Long Term Capital Asset.
5.7 The above treatment of capital gain as short term capital gain is also supported by the circular No.2 of 2002, which was published on 15-2-2002. The assessee was very well aware of this circular prior to filing of the return of income. As per Para 5.1 of this circular, the capital gain in case of sale of DDBs will always be a short term capital gain. The reliance of the assessee on a press note dated 20-3- 2002 is misplaced because as per circular 783 dated 18-11-2001, the claims made on the basis of press notes are not sustainable, especially when the Circular itself was clarifying the existing provisions of the Act.
5.8 In the light of above observations, it is concluded that the income generating from the purchase of 850 DDBs, Series-A of Nirma Ltd. dated 01.10.01 of Rs.1,44,50,000 is interest income. The TDS credit of Rs.29,47,800 is allowed on the same.
(Addition of Interest Income 1.44.50,000)"
6 Ground No.5 of the appeal reads as under:"In law and in facts and circumstances of the Appellant's case, the Ld. Commissioner of Income-tax (Appeals) has erred in upholding the action of ld. Assessing Officer in considering the long term capital gain of Rs.2,21,55,222/- on sale of 1002 Deep Discount Bonds of Nirma Limited as short term capital gain.
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7 The Learned Assessing Officer observed as under:-
"5.9. The assessee sold the rest of 1002 DDBs as on 19.03.02 at a total consideration of Rs.12,23,55,222, meaning thereby each bond was sold at Rs.1,22,111. The purchase consideration of the same was Rs.10,02,00,000. Therefore the STCG on the same is computed at Rs.2,21,55,222.
(Addition of STCG 2.21.55.222)"8 Ground No.4 and 6 of the appeal read as under:-
"4 In law and in facts and circumstances of the Appellant's case, the Ld. Commissioner of Income-tax (Appeals) has erred in upholding the action of ld. Assessing Officer in not allowing claim u/s 54EC of the I.T. Act on long term capital gain referred to in ground no.3 above.
6 In law and in facts and circumstances of the Appellant's case, the Ld. Commissioner of Income-tax (Appeals) has erred in upholding the action of ld. Assessing Officer in not allowing claim of deduction u/s 54EC of the Act on long term capital gain referred to in ground no.5."
9 The Learned Assessing Officer observed as under:-
"5.10 The claim of deduction u/s. 54EC of IT. Act of Rs.3,66,00,000 is not allowed to the assessee since the same can be claimed only against the LTCG as per the provisions of the ACT."10 Ground No.7 of the appeal reads as under:-
"7 In law and in facts and circumstances of the Appellant's case, the Ld. Commissioner of Income-tax (Appeals) has erred in upholding the action of ld. Assessing Officer in considering Rs.48,83,858/- as accrued interest on holding of 1250 Deep Discount Bonds, series-B of Nirma Limited each of Rs.1,00,000/- acquired on 08-10-01 and held till end of the year applying the Circular dated 15-02-02 of CBDT on the basis of assumption and surmise and ignoring submissions, including press note issued by CBDT, in this regard.
Ld. CIT(A) has further erred in upholding the Assessing Officer's action, while making the addition of Rs.48,83,858/-, relying on circular No.2 of 2002 of CBDT dated 15-02-02 and ignoring the press note dated 20-03-02 issued in this regard by CBDT.
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Ld. CIT(A) has further erred in upholding the Assessing Officer's action, while making the addition of Rs.48,83,858/-, making the circular applicable with retrospective effect, which is illegal and against the interest of the appellant.
Ld. CIT(A) has further erred in upholding the Assessing Officer's action, while making the addition of Rs.48,83,858/-, assuming the discount rate for the years 2005 to 2010 and gross error in making calculations purely based on assumption, conjecture and surmise."
11 The Learned Assessing Officer observed as under:-
"5.11 In the matter of DDB, Series-B, the assessee was allotted the 1250 DDBs of Rs.1,00,000 each. The maturity value of the same after 20 months is Rs.1,15,500. The assessee was asked to explain as to why the interest should not be added on the same. The value of a security increases in a market on day to day basis because as the time passes the maturity date nears down. In case of a secured debenture the liquidity is highly assured. Therefore it can be safely concluded that the gain in a security accrues on annual basis even though the exp. may not accrue in the hands of the issuer of the security.
As has been produced above, from the Circular of the Board dated 15.02.02, it Ii very clear that the interest should be offered by the assessee on accrual basis irrespective of the fact what method of accounting is adopted by him. In this case it has been established that the assessee has to adopt the mercantile system of accounting therefore it is the duty cast on the assessee by law to show the interest on accrual basis. The resort of the assessee on the press release of CBDT is of no use because the intention of legislature has always been to tax the income on securities on accrual basis as has been established above.
Further it has been shown above that there is a collision between the issuer of these bonds and the director that the company will claim the interest on the accrual basis and the holders will not offer the income on accrual basis.
The assessee was asked to furnish the explanation as to why the interest should not be added on these bonds on accrual basis but as discussed above no cogent explanation in this regard could be furnished by the assessee, therefore the same is computed as under on the basis of discounted price. The discounted value is taken as per the following table. The value
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as on 31.03.2002 is 15 months back to the redemption date which is 20 months from the date of allotment i.e. as on 06- 06-03. The Discounted value of these DDBs as on 31-03-02 is computed as under:
Maturity value (face value) [1+r/100]n Here r is prevailing discounting rate in Indian Economy and n is the remaining period before maturity. The range of prevailing discounting rate r is as under:
1999 10.05.-11.50
2000 10.00-12.00
2001 8.75-11.25
2002 7.41-10.25
2003 6.00-7.75
2004 4.70-6.50
Thus the average of range for 2002 is 8.83.
The discounted value is as under:
Discounted value = 1,15,500 x 1250 = 14,43,75,000=
12,98,83,858
(1+0.0883)15/12 1.11157
Thus the accrued interest / gain on the same is computed at Rs.48,83,858/-. In the light of the above observations, the addition of this amount is made in the hands of the assessee.
(Addition of accrued interest 48,83,858)"12 Ground No.8 of the appeal reads as under:-
"8 In law and in facts and circumstances of the Appellant's case, the Ld. Commissioner of Income-tax (Appeals) has erred in confirming the Assessing Officer's action in levying interest of Rs.44,27,137/- u/s 234B of the I.T. Act.
13 The Learned Assessing Officer observed as under:-
"Thus the income is assessed u/s 143(3) of the Act. Demand notice is issued after giving credit for taxes paid / adjusted after due verification. Interest u/s 234A, 234B & 234C is charged."14 Ground No.9 in the appeal reads as under:-
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"9. In law and in facts and circumstances of the Appellant's case, the Ld. Commissioner of Income-tax (Appeals) has erred in not interfering on the ground relating to initiation of penalty proceedings u/s 271(1)(c) of I.T. Act".
15 The Learned Assessing Officer observed as under:-
"6 The penalty proceedings u/s 271(1)(c) are initiated in this case for furnishing the inaccurate particulars of income and thereby concealing the income."
16 The Learned Commissioner of Income-tax (Appeals) has decided the above issues simply by observing as under:-
"All the grounds of appeal have been dealt with in the appellate order No.CIT(A)-I/CC.1(1)/46/05-06 dated 7/3/06 for AY 2002-03 in the case of Harsiddh Specific Family Trust and jShri Karsanbhai K Patel (HUF) for AY 2002-03 in appeal No.CIT(A)-I/CC.1(1)(/35/05-06 dated 2/3/06. Hence, following the above appellate orders, Ground of appeal No.1 to 7 are dismissed."
17 We find that the Learned Commissioner of Income-tax (Appeals) has not given the reasons while deciding the appeal of the assessee. Thus, the order passed by the Learned Commissioner of Income-tax (Appeals) is a non-speaking order. The Learned Commissioner of Income-tax (Appeals) has relied on his order passed in the case of Harsiddh Specific Family Trust and Shri Karsanbhai K Patel (HUF). It is the duty of the Learned Commissioner of Income-tax (Appeals) to give reasons for each grounds of appeal decided by him so that the aggrieved party can plead his case before the higher forum who can also appreciate the decision of the Learned Commissioner of Income-tax (Appeals). Thus, we are unable to adjudicate the appeal of the assessee. Hence the order of the Learned Commissioner of Income-tax (Appeals) is set aside and the matter is remanded back to his file to pass a well-
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reasoned and speaking order after allowing reasonable and proper opportunity of hearing.
18 In the result, the appeal is allowed for statistical purpose.
Order signed, dated and pronounced in the court 29-01-2010.
Sd/- Sd/- ( T.K. SHARMA ) ( N.S. SAINI ) JUDICIAL MEMBER ACCOUNTANT MEMBER Ahmedabad; Dated 29 /01/2010 Copy of the Order forwarded to : 1. The Appellant 2. The Respondent 3. The CIT Concerned 4. The ld. CIT(Appeals)-XIV, Ahmedabad. 5. The DR, Ahmedabad Bench 6. The Guard File.