Commissioner Of Income-Tax vs Intermetal Trade Ltd. on 18 July, 2006

[Cites 10, Cited by 7]

Madhya Pradesh High Court

Commissioner Of Income-Tax vs Intermetal Trade Ltd. on 18 July, 2006

1. This is an appeal filed by the Commissioner of Income-tax, under Section 260A of the Income-tax Act, 1961 against an order dated November 15, 2002, passed by the Income-tax Appellate Tribunal, Indore Bench, Indore, in I. T. A. No. 32/Ind/2001,. The appeal was admitted for final hearing on the following substantial question of law:

Whether, the Income-tax Appellate Tribunal was justified in holding that the Explanation to Section 73 of the Income-tax Act is not applicable to the case of the appellant ?

2. The respondent (assessee) is a limited company registered under the provisions of the Companies Act. It is engaged in the business of trading in metal and shares. The assessee for the assessment year 1997-98, inter alia, claimed that they suffered a loss of Rs. 34,52,514 in their share business (i.e., sale and purchase of various shares). It is this loss incurred by the assessee which was claimed as set off against the profit earned by them from their other activities, i.e., other business. The Assessing Officer was of the view that the assessee is not entitled to claim the set off of the loss suffered by them in share business by virtue of the Explanation appended to Section 73 of the Act. The Assessing Officer was of the view that since the loss incurred by the assessee was in speculative business, i.e., sale and purchase of shares, and hence, it can be set off only against the profit earned by the assessee from similar kind of speculative business but not against the profit earned by them from non-speculative business. The assessee was, therefore, asked to show cause, as to why the claim of loss amounting to Rs. 34,52,514 sustained by the assessee be not disallowed by the Assessing Officer by taking recourse to the provisions of Section 73 read with its Explanation. The contention of the assessee to this show cause was that neither Section 73, nor its Explanation applies to them. It was their case that their case falls in the excepted category of companies defined in the Explanation and hence, they come out of the rigour of Section 73 and its Explanation. It was contended that the business of the company is also that of "granting of loans and advances" as is clear from the objects of memorandum and articles of association of the company as also the interest earned by the assessee from the loan advanced during the year in question. It was, therefore, contended that the company is also engaged in the business of "granting loan and advance" as defined in the Explanation appended to Section 73 and hence, falls in the excluded categories of company for the purpose of inapplicability of Section 73. It was thus contended that the assessee is entitled to claim the set off of the loss amounting to Rs. 34,52,519 incurred by them in share business as against the profit earned by them from other trading business activities as detailed in the returns in the assessment year in question de hors Section 73, i.e., without attracting the provisions of Section 73 ibid.

3. The Assessing Officer by order dated March 31, 2000, did not accept the contention of the assessee. While thus rejecting this contention he proceeded to invoke the provisions of Section 73 read with its Explanation by disallowing the deduction claimed of the loss amount. This is what the Assessing Officer held in his order dated March 31, 2000, while rejecting this contention of the assessee:

Though the assessee-company had stated that physical delivery of the shares purchased was taken, the assessee-company has not furnished any evidence in respect of from whom the shares were purchased and to whom they were sold and has not furnished proof in respect of delivery of the shares. It is also difficult to believe that how the assessee was able to get physical delivery of shares in such a short time. But, even if such shares loss was occasioned on shares for which physical delivery was taken. Under the provisions of Section 73 the assessee cannot claim set off of the shares as against profit from other activities.

The assessee's contention, that because of large volume of share trading the same constituted its main activity and hence share trading loss cannot be disallowed by invoking the provisions of Section 73. This contention has absolutely no merit as the major income during the year was received from metal trading as the very fact that despite adjustment of actual loss on shares the assessee has shown positive income clearly establishes that the main activity is that of metal trading activities hence the provisions of Section 73 gets clearly attracted and the assessee shall be allowed set-off of such loss of Rs. 34,52,514 against other income. The same shall however be allowed to be carried forward as speculation loss to be adjusted against future speculation profit as and when they arrive in accordance with the provisions of law.

4. The assessee felt aggrieved by the aforesaid order, filed an appeal to the Commissioner of Income-tax (Appeals). By order, dated November 31, 2000, the Commissioner of Income-tax (Appeals) upheld this part of the order passed by the Assessing Officer by holding as under:

So far as the appellant company is concerned as discussed earlier it is neither an investment company nor a banking company but a trading company. The assessee-company dealt in shares besides having other business. Thus the loss suffered in purchase and sale of shares is to be treated as speculation loss under the Explanation to Section 73. The Mumbai Bench of the Income-tax Appellate Tribunal in the case of Rajan Enterprises P. Ltd. v. ITO reported in [1992] 41 ITD 469 has held to determine whether an assessee is an investment company or not, one has to determine what its gross total income. The Calcutta Bench of the Income-tax Appellate Tribunal in the case of Off-shore India Ltd. v. ITO reported in [1986] 15 ITD 549 has held where amount invested by an assessee in share business was much more than that which was invested in money-lending business and income chargeable under the head 'Profits and gains of business or profession' was much more than chargeable under the head 'Income from other sources', it could not be said that the assessee fell within the first or second exception to the Explanation to Section 73. In the case of the appellant company the investment made in shares is several times higher than the amount invested by way of loans and advances. Similarly, investment made in metal business is also higher than that of loans and advances as is reflected in the balance-sheet. As stated earlier, the loans and advances are of surplus fund not required immediately for the business purpose had only been invested. The memorandum and articles of association clearly incorporates the object of the company is not to carry on any banking business and nor is the appellant company carrying on any money-lending business. Thus I reach a conclusion that granting loans and advances and earning interest thereon is not the principal business activity of the appellant company rather its chief activity is trading in shares and trading in metal. This view is affirmed by the volume of business in terms of turnover, gross profit and investment patterns, etc. In the backdrop of the aforesaid discussion I arrive at the inescapable conclusion that the Explanation to Section 73 is clearly attracted and the loss suffered in purchase and sale of shares of Rs. 34,52,514 during the year is to be treated as speculative loss which cannot be set off against income from other business activity or income shown under other heads of income. I approve of the Assessing Officer's action in applying the Explanation to Section 73 and the loss suffered in share dealings has rightly been treated as speculative loss. This ground of appeal thus stands rejected.

5. The assessee felt aggrieved by the aforesaid order of the Commissioner of Income-tax (Appeals) and pursued the issue by filing appeal to the Tribunal. By the impugned order, the Tribunal allowed the appeal and set aside the orders passed by the Assessing Officer and the Commissioner of Income-tax (Appeals). This is how the Tribunal concluded while allowing the appeal filed by the assessee and setting aside the orders passed by the Assessing Officer and the Commissioner of Income-tax (Appeals):

In other words, an investment company dealing in shares shall be considered to be trading in shares and not doing speculation business. In that view of the matter, the losses suffered by an investment company on the purchase and sale of shares have to be adjusted against other income. In view of these ratios and the facts of the case, we hold that the Explanation to Section 73 is not applicable to the appellant and the loss from share has to be adjusted against other income during the year. Thus, we set aside the order of the Commissioner of the Income-tax (Appeals) and direct the Assessing Officer to allow loss from purchase and sale of shares against other income of the assessee.

6. It is against this order the Commissioner of Income-tax has felt aggrieved and filed this appeal which as stated supra, was admitted for final hearing on the aforementioned substantial question of law.

7. Heard Shri R. L. Jain, learned senior counsel with Ku. V. Mandlik, learned Counsel for the appellant, and Shri Sarda, for the respondent.

8. Learned counsel for the appellant (Revenue) while assailing the impugned order of the Tribunal contended that the Tribunal erred in holding that Section 73 and its Explanation does not apply to the case of the assessee. According to learned Counsel, a plain reading of Section 73 read with its Explanation would clearly indicate that the case of the assessee falls within the four corners of Section 73 read with the Explanation appended thereto. It was urged that the assessee (company) was not a company falling in any of the excluded categories of companies defined in the Explanation and hence loss sustained by the assessee in share business shall be deemed to be in speculation business to the extent to which the business consists of purchase and sale of shares for the purpose of applicability of Section 73 ibid. Learned counsel, therefore, urged that in these circumstances, the view taken by the Assessing Officer and upheld by the Commissioner of Income-tax (Appeals) deserves to be upheld as against the view so taken by the Tribunal. In reply, learned Counsel for the assessee supported the impugned order of the Tribunal.

9. Having heard learned Counsel for the parties and having perused the record of the case, we are inclined to allow this appeal and set aside the order of the Tribunal impugned herein.

10. Section 73 and Section 43(5) which alone are relevant for disposal of this appeal read as under:

73. Losses in speculation business.(1) Any loss, computed in respect of a speculation business carried on by the assessee, shall not be set off except against profits and gains, if any, of another speculation business.

(2) Where for any assessment year any loss computed in respect of a speculation business has not been wholly set off under Sub-section (1), so much of the loss as is not so set off or the whole loss where the assessee had no income from any other speculation business, shall, subject to the other provisions of this Chapter, be carried forward to the following assessment year, and:

(i) it shall be set off against the profits and gains, if any, of any speculation business carried on by him assessable for that assessment year; and

(ii) if the loss cannot be wholly so set off, the amount of loss not so set off shall be carried forward to the following assessment year and so on.

(3) In respect of allowance on account of depreciation or capital expenditure on scientific research, the provisions of Sub-section (2) of Section 72 shall apply in relation to speculation business as they apply in relation to any other business.

(4) No loss shall be carried forward under this section for more than eight assessment years immediately succeeding the assessment year for which the loss was first computed.

Explanation.Where any part of the business of a company other than a company whose gross total income consists mainly of income which is chargeable under the heads 'Interest on securities', Income from house property', 'Capital gains' and 'Income from other sources' or a company the principal business of which is the business of banking or the granting of loans and advances consists in the purchase and sale of shares of other companies, such company shall, for the purposes of this section, be deemed to be carrying on a speculation business to the extent to which the business consists of the purchase and sale of such shares.

Section 43(5) 'speculative transaction' means a transaction in which a contract for the purchase or sale of any commodity, including stocks and shares, is periodically or ultimately settled otherwise than by the actual delivery or transfer of the commodity or scrips:

Provided that for the purposes of this clause:

(a) a contract in respect of raw materials or merchandise entered into by a person in the course of his manufacturing or merchanting business to guard against loss through future price fluctuations in respect of his contracts for actual delivery of goods manufactured by him or merchandise sold by him ; or

(b) a contract in respect of stocks and shares entered into by a dealer or investor therein to guard against loss in his holdings of stocks and shares through price fluctuations ; or

(c) a contract entered into by a member of a forward market or a stock exchange in the course of any transaction in the nature of jobbing or arbitrage to guard against loss which may arise in the ordinary course of his business as such member:

shall not be deemed to be a speculative transaction:

11. The provisions of the Explanation to Section 73 have to be contrasted with the provisions of Section 43(5), which defines "speculative transaction" to mean a transaction in which a contract for the purchase or sale of any commodity, including any stock and share, is periodically or ultimately settled otherwise than by the actual delivery or transfer of the commodity or scrips. The Explanation to Section 73 treats any purchase and/or sale of shares by certain companies to be speculative for the purpose of Section 73 only. For the purpose of setting off and carrying forward of loss, buying and selling of shares of certain companies is regarded by the statute as speculation business, even though the transaction of purchase and sale was followed by deliver of scrips and as such cannot be treated as "speculative transaction" as defined in Section 43(5) of the Income-tax Act.

12. The rules relating to set off and carry forward of losses are contained in Sections 70 to 79 of the Income-tax Act. Section 70 provides for set off of loss from one source against the profit from another source under the same head of income. Section 71 permits setting off of loss under one head of income against the income under any other head. Section 72 lays down the rules for carry forward and set off of business losses. If the net result of the computation under the head "Profits and gains of business or profession" is a loss and such loss cannot be or is not wholly set off against the income under any other head of income in accordance with the provisions of Section 71, then the amount of loss which has not been set off can be carried forward to the following assessment year. Such losses carried forward from the previous year can be set off against the profits and gains of business in the subsequent assessment year. This rule is subject to the provisions that the business or profession in which the loss was originally incurred will have to continue to be carried on by the assessee in the previous year in which the loss is sought to be adjusted. In other words, if an assessee suffers loss in any business and closes down that business, then such loss cannot be carried forward and adjusted against profits of some other business in the subsequent assessment year. Section 72 specifically excludes loss sustained in speculation business from its ambit. That means that, when a loss is sustained in a speculation business, that cannot be carried forward to be adjusted against any other business loss.

13. Section 73 specifically deals with losses in speculation business. Sub-section (1) of Section 73 restricts the scope of Section 70 which permits the setting off of loss from one source against the profit from another source falling under the same head of income and Sub-section (1) of Section 73 categorically declares that any loss arising from speculation business shall not be set off except against profits and gains of another speculation business. In other words, if there is a speculation loss and also gain from another source of non-speculation business, then such speculation loss cannot be set off against the profit from a non-speculation business. Sub-section (2) of Section 73 restricts the scope of Section 72 which provides for carrying forward and set off of business losses. If any loss computed in respect of a speculation business has not been wholly set off, such loss may be carried forward and set off against profits and gains of any speculation business in the following assessment years. The Explanation to Section 73 introduces a legal fiction. The section applies only to a company. It does not apply to individuals, firms, Hindu undivided families or association of persons. The Explanation also does not apply to an investment company or a company whose principal business is banking or money-lending. If the business of a company which does not fall within the excluded categories consists of purchase and sale of shares of other companies, then such a company shall be deemed to be carrying on speculation business for the purpose of Section 73 to the extent to which the business consists of the purchase and sale of such shares.

14. In other words, only those companies whose gross total income consists mainly of income which is chargeable under the heads "Interest on securities", "Income from house properties", "Capital gains" and "Income from other sources", or companies whose principle business is of "banking or granting of loans and advances" are exempt from the applicability of Section 73.

15. In our considered opinion, the respondent/assessee does not fall in any of the excepted categories of companies specified in the Explanation to Section 73 ibid. Firstly, it is not a company whose main source of income is from "interest on securities" or "income from house property", or from "capital gains", or "other sources". Secondly, it is also not a company whose principal business is that of "banking or granting of loan and advance".

16. In order to come out of the clutches of Section 73, it is necessary for the assessee to show that they satisfy the requirement of excepted categories because of their main business activity. The emphasis on the word "mainly" and/or "principal business" used in Section 73 ibid is significant. It cannot be lost sight of or ignored while deciding the applicability of Section 73 ibid. A particular company may have income from any of these specified sources but, that is not enough. In order to exclude the applicability of Section 73, it must be further proved that the gross total income of the company is mainly from these or any of these sources. It is only on proof of this fact that the assessee can come out of the rigour of Section 73 ibid.

17. We do not agree with the submission of learned Counsel for the assessee when he urged that the main business of the company is that of sale and purchase of shares and granting of loans and advances and therefore, the case of the assessee falls in the excepted category of the company defined in the Explanation. In the first place, the main business of the assessee/company is that of trading in metals and shares. It is clear from Clauses 10, 11 and 12 (reproduced by the Commissioner of Income-tax (Appeals) in his order in para. 8) of the memorandum of association. Secondly, granting of loan/advances by the assessee cannot be regarded as "principal business" of the assessee because, as observed supra, earning of interest on some deposit/loan given by the assessee is one thing and making this activity the principal business activity is entirely another thing. Thirdly, on the facts found by the Assessing Officer/the Commissioner of Income-tax (Appeals), the main activity of the assessee being trading in metal and shares and not in granting advances/loans no benefit of the excepted category is available to the assessee. Fourthly, it is also clear from the figures of turnover of the assessee that the main activity is that of trading in metal and shares and lastly, the so-called loans and advances were given by the assessee to their own persons who are either closely related to the directors of company or to those who have a trading account with the assessee in their day-to-day business activities.

18. In our considered opinion, thus, the case of the assessee squarely falls within the four corners of Section 73 ibid by virtue of the Explanation, inter alia, for the reasons, that firstly, part of the business of the assessee consists in the purchase and sale of shares of other companies. Secondly, by virtue of this part of the business, the assessee is deemed to have engaged themselves in speculation business as defined in the Explanation appended to Section 73. Thirdly, the assessee is not engaged in any of the specified excluded categories of business so as to come out of the clutches of Section 73. In these circumstances, the loss suffered by the assessee in share business being in the nature of speculative business by the deeming fiction contained in the Explanation, it cannot be set off against the profit earned by the assessee from the non-speculative business but it can be set off only in accordance with the provisions of Section 73. Our view finds support from the Circular No. 204, issued by the Central Board of Direct Taxes dated July 24, 1976 (see [1977] 110 ITR (St.) 21), which has explained the scope and effect of the Explanation appended to Section 73 (see Chaturvedi and Pithisaria, Vol. 2, fourth edition page 2351).

19. In view of the foregoing discussion, the appeal succeeds and is allowed. The impugned order is set aside and that of the Assessing Officer and the Commissioner of Income-tax (Appeals) restored.

20. No costs.

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Madhya Pradesh High Court