Gujarat High Court
Commissioner Of Income Tax vs Mohanlal Ranchhoddas on 9 September, 1992
Equivalent citations: [1993]203ITR304(GUJ)
Author: S.B. Majmudar
Bench: S.B. Majmudar
JUDGMENT S.D. Shah, J.
1. On being directed by this Court under s. 256(2) of IT Act, 1961, the Income-tax Appellate Tribunal has referred the following questions of law for our opinion :
"(1) Whether, the claim of the assessee, namely, that it converted investment in Atul Products and Arvind Mills shares as stock-in-trade on 9th November, 1961, i.e., being opening day of S.Y. 2018, and utilised the same for the purpose of ready business, is supported by evidence on record and consequently whether the claim of the respondent is admissible in law ?"
"(2) Whether, the loss of Rs. 5,28,578 for asst. yr. 1963-64 as claimed by the assessee is allowable in accordance with the provisions of s. 43(5) of the IT Act, 1961 ?"
"(3) Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in entertaining the appeal of the assessee, rejecting the preliminary objection of the Revenue that the point at controversy was concluded by the decision of the Tribunal in IT Appeal Nos. 225 and 226 (Ahd). 1970-71 decided on 11th September, 1972 against the order of the CIT ?"
2. It may be stated that two reference applications being Reference Application Nos. 42 and 43 were preferred before the Tribunal and two IT Applications being IT Application Nos. 29 and 30 were preferred to this Court when this Court required the Tribunal to draw up the statements of case and refer the question of law and thereupon the Tribunal has referred the aforesaid questions to us by two separate reference applications. These two references, therefore, ought to have been registered separately, but the Registry of this Court has consolidated the same in view of the fact that one statement of case is prepared by the Tribunal. We, accordingly, direct the Registry of this Court to register the aforesaid references as IT Ref. Nos. 153/78 and 153A/78.
3. Before we proceed to deal with the aforesaid questions of law, it would be necessary to set out the relevant facts in the context of which we are required to answer the aforesaid questions of law :
(i) The assessee is an unregistered firm which derived income from dividends and speculations in shares. For the asst. yr. 1963-64 the previous year is S.Y. 2018, i.e., from 9th November, 1961 to 28th October, 1962. For the asst. yr. 1964-65 the previous year is S.Y. 2019. The assessee held 450 shares for Atul Products and 332 shares of Arvind Mills Ltd. at the beginning of S.Y. 2018 being previous year is 1963-64.
(ii) On the first day of S.Y. 2018 corresponding to English date 9th November, 1961 according to assessee he converted his ready share business in Atul Products shares and Arvind Mills Ltd. shares as stock-in-trade. Accordingly, the assessee had also placed an entry in its books of account. On the basis of market value of the said shares as on the date, the assessee claimed that the value of shares of Atul Products and Arvind Mills Ltd. should be considered as value of stock-in-trade and the said value should be adjusted against sale price realised by the assessee. It may be mentioned that the assessee sold shares of Arvind Mills Ltd. for a sum of Rs. 3,17,945 and 250 shares of Atul Products out of 450 shares for a sum of Rs. 1,19,918. These shares were sold in the asst. yr. 1963-64. The balance 200 shares of Atul Products were sold in the asst. yr. 1964-65. As a consequence of this transaction of sales based on conversion of investment in the said shares into stock-in-trade the assessee claimed adjustment loss of Rs. 5,28,578.
(iii) The ITO found that for the asst. yr. 1963-64 no books of accounts were maintained except incomplete cash books prepared by the assessee on the basis of ankadas received from the brokers, etc. He also found that the assessee was holding the aforesaid shares in the two scrips since S.Y. 2011 and dividends therefrom were being shown. He, therefore, found that the assessee had sold the said shares which were held by him by was of investment with a view to meeting heavy speculation losses. He also found that in the earlier years there were no sales and purchase transaction by handing over and taking over of shares on delivery basis in any of the said shares. He, therefore, disallowed the claim of the assessee for conversion of investment into stock-in-trade and he held that the shares in the aforesaid two scrips represented investment in shares and, therefore, he treated the income as capital income liable to tax. It may be stated that for the asst. yr. 1964-65 by the same process of reasoning the sale price of 200 balance shares of Atul Products was bought to tax as capital gains.
(iv) Being aggrieved by the aforesaid order of the ITO, the assessee carried the matter in appeal before the AAC. However, before the appeal could be decided the CIT acting under s. 263 of the Act initiated proceedings as he was of the view that the assessment order made by the ITO was erroneous and was prejudicial to the interest of the Revenue. After giving opportunity to the assessee to file his reply and after hearing the assessee the CIT came to the conclusion that the assessee was holding shares as stock-in-trade right from the beginning when the said shares were acquired. In alternatively, he held that the purchase and sale of shares of Arvind Mills and Atul Products will represent an adventure in the nature of trade and that it cannot be accepted that the assessee had converted the said shares from investment to stock-in-trade on 9th November, 1961. He, therefore, held that the profits as computed by the ITO should be assessed as business profit.
(v) Being aggrieved by the order of CIT the assessee carried the matter in appeal to the Tribunal and the Tribunal in Income Tax Appeal Nos. 225 and 226(Ahd)/1970-71 held that the shares of Arvind Mills Ltd. and Atul Products were investment shares and that the ITO was right in bringing the profits thereon to tax as capital gains. The decision of the CIT was, therefore, reversed. It may be mentioned that while the aforesaid appeals against the order of the CIT were heard by the Tribunal, the appeals preferred by the assessee against the order of ITO disallowing the case of the assessee that he converted his investment assets into stock-in-trade in the aforesaid two scrips were pending before the AAC. The Tribunal, therefore, in the said order mentioned that the assessee's case that his investment assets were converted into stock-in-trade on the first day of the relevant year was not within the scope of the appeals before the Tribunal.
(vi) In the appeals which were preferred by the assessee before the AAC, initially the AAC did not deal with the nature and the character of holding of shares of Atul Products and Arvind Mills as the said question was the subject-matter of appeal before the Tribunal against the order of the CIT. The AAC, therefore, initially declined to interfere with the order passed by the ITO. However, when the Tribunal disposed of the aforesaid appeals being IT Appeal Nos. 225 and 226 the assessee approached the AAC to restore his appeals and pressed that the points raised by him in his appeal about the conversion of his investment assets into stock-in-trade on the first day of the accounting year relevant to the asst. yr. 1963-64 was required to be decided. The AAC disposed of said contention by holding that the assessee's claim for conversion of investment into stock-in-trade in respect of shares was not acceptable.
(vii) Being aggrieved by the order of the AAC the assessee preferred appeal to the Tribunal and the Tribunal after considering the contentions advanced before it came to the conclusion that the assessee had effected conversion of scrips of shares of Arvind Mills and Atul Products appearing on investment account into ready share accounts. The Tribunal also held that there was nothing on record to doubt the entries in the books of accounts of the assessee, more particularly, entry of 9th November, 1961. On the question regarding the allowance of loss, the Tribunal found that since the transaction in regard to the purchase and sales of shares were settled by way of differences ultimately did not exceed the total quantity of scrips handed over to the brokers, the claim of the assessee of hedging the loss was allowed (sic). The Tribunal, therefore, allowed the appeals of the assessee. The aforesaid judgment of the Tribunal has given rise to the aforesaid questions of law for our opinion.
4. Question No. 1 - Conversion of investment into stock-in-trade - whether permissible ?
(a) In the course of assessment proceedings, the assessee claimed that his business in Atul Products shares and Arvind Mills shares should be treated as "ready share business" and that he should to convert his investments in the said shares into stock-in-trade at the market value of opening day of S.Y. 2018 corresponding to English calendar day, i.e., 9th November, 1961. On the basis of the market value of said shares on that day, the value of shares of Atul products and Arvind Mills Ltd. should be considered and the said value should be adjusted against the sale price relaised by the assessee. The assessee accordingly claimed that adjustment loss of Rs. 5,28,578 should be allowed for the asst. yr. 1963-64. The claim of the assessee for conversion of his investment into stock-in-trade was negatived by the ITO because firstly, the assessee did not carry on ready share business in the said scrips of Arvind Mills Ltd. and Atul Products since S.Y. 2011, secondly the assessee held the shares by way of his investment since S.Y. 2011 and he had never sold the said shares, thirdly, the said shares were sold during respective year with a view to meet the heavy speculation loss incurred by it, fourthly, there were no sales and purchase transaction in the scrips of the aforesaid two companies in the earlier years, and lastly, because the assessee did not make any sale or purchase transaction of handing over and taking over on delivery basis in any of these shares during the respective accounting year, but the entire block was sold. The claim of the assessee for conversion of investment into stock-in-trade, thus, came to the disallowed. The AAC confirmed that view while the Tribunal has allowed the appeal of the assessee.
(b) In the aforesaid fact situation, we are called upon to decide the question as to whether the assessee who held investment shares in Atul Products and Arvind Mills Ltd. was entitled in law to convert his investment into shares by converting them into stock-in-trade so as to commence business in shares and subsequently to claim adjustment loss. In the case of CIT vs. Bai Shirinbai K. Kooka reported in (1962) 46 ITR 86 (SC) a Bench of seven Judges of the Supreme Court speaking through S. K. Das, J. (Sarkar, J. dissenting) was called upon to decide identical question. Before the Supreme Court, the assessee, a parsi lady held by way of investment a large number of shares of different companies. The dividend income from such shares was assessed to income-tax for several years prior to 1st April, 1945. The assessee converted her shares into her stock-in-trade and carried on trading activity, namely, "business in shares". Her income for the asst. yr. 1946-47 was computed on the basis of profits which she made by the sale of her shares as trading activity the profits being calculated on the difference between the ruling market price at the beginning of accounting year and the sale proceeds. The ITO calculated the profits by deducting from the sale proceeds the cost calculated on the basis of market price of shares at the beginning of the accounting year. The question before the Court was : What should be the basis of computation of the profits made by the assessee by the sale of her shares in the relevant year ? The Supreme Court held that in order to arrive at real profits one must consider the accounts of business on commercial principles and construe profits in their normal and natural sense, a sense which no commercial man will misunderstand. Normally, the commercial profits out of the transaction of a sale of an article is the difference between what the article costs the business and what it fetches on sale. So far as the business or trading activities are concerned, market value of the shares on the conversion date was what it cost business. There was no question of notional sale. The shares which were converted into stock-in-trade were sold by the assessee which was an actual sale and not a notional sale. Such sale has resulted into profit and the question was as to how such profit should be computed. The Supreme Court adopted the language of Lord Radcliffe and held that "the only fair measure of assessing the trading activities in such circumstances is to take the market value at one end and the actual sale proceeds at the other, the difference between the two being the profit or loss, as the case may be.". In this case the Supreme Court was also required to consider whether the majority decision of the Supreme Court in the case of Sir Kikabhai Premchand vs. CIT reported in (1953) 24 ITR 506 (SC) requires reconsideration. In Sir Kikabhai's case (supra) a part of stock-in-trade was withdrawn from business; there was no sale nor any actual profit. The ratio of the decision was that under the IT Act the State has no power to tax a potential future advantage; all it can tax is income, profits and gains made in the relevant accounting year. While the Supreme Court found that in the case before it (Kikabhai's case) the admitted position was that there has been sale of shares in pursuance of a trading or business activity and actual profits have resulted from the share. The question before the Court was not whether the State has power to tax potential future advantage, but the question was how the actual profits be computed when admittedly there has been sale in the business sense and actual profits have resulted therefrom. The Supreme Court referred to the decision of the House of Lords in Shrkey vs. Wamher reported in (1955) 36 TC 275 (HL). In the said case the wife of the assessee carried on a stud farm, the profits of which were agreed to be chargeable to income tax under case I Schedule D. She also carried on the activities if horse racing and training, which were agreed not to constitute trading. Five horses were transferred from the stud farm to the racing stables. The cost of breeding these horses was debited to the stud farm accounts. On the question of the amount to be credited as a receipt, the assessee contented before the Special Commissioners that he proper figure to be brought in respect of the transferred horses was the cost of breeding. The Revenue contended that the market value of the animals, which was considerably higher, was the proper figure. The House of Lords decided in favour of the assessee. Lord Radcliffe pointed out that when a horse was transferred from the stud farm to the owner's personal account, there was a disposition of trading stock, though the disposition might not be by way of trade. He then referred to the tree methods of recording the result of the disposition in the stud farm trading accounts. One of them was that there might be no entry of a receipt at all and Lord Radcliffe pointed out that this method would give the self-supplier an unfair tax advantages. The second method would be to enter the cost price; this again would be fictional because no sale in the legal sense had taken place, nor had there been any actual receipt. The third method was to enter as a receipt a figure equivalent to the current realisable value of the stock item transferred. Lord Radcliffe gave two grounds in favour of the third method. The first ground was that it gave a fairer measure of assessable trading profit as between one taxpayer and another, for it eliminated variations which were due to no other cause than any one taxpayer's decision as to what proportion of his total product he would supply to himself. The second ground was that it was better economics to credit the trading owner with the current realisable value of any stock which he had chosen to dispose of without commercial disposal than to credit him with an amount equivalent to the accumulated expenses in respect of that stock.
(c) Based on the above opinion of the House of Lords, the Supreme Court determined the actual profits by taking the market value on one hand and the actual sale proceeds at the other, the difference between the two weighing the profit or loss, as the case may be. From the aforesaid decision it becomes clear that the shares held as investment assets can be converted into stock-in-trade of business in shares and such shares can be sold subsequently, and to such conversion there does not appear to be any legal impediment. However, factually it shall have to be seen as to whether the transaction of such conversion was genuine and was supported by evidence on record. True it is, that such an exercise would indirectly invite this Court to re-appreciate the findings already reached by the authorities, but if we turn to the language employed in question No. 1 referred to us for our opinion, we shall have to at least refer to the evidence in order to record our opinion as to whether the transaction of conversion is supported by evidence on record.
(d) We may first refer to copy of entry posted in the journal of S.Y. 2018 on Kartik Sud 1 which according to English calendar year would be referable to 9th November, 1961. As per said entry amount of Rs. 6,68,980 is referable to conversion of shares of Arvind Mills Ltd. and Atul Products into business and as such market value thereof is credited to ready share business at purchase price debiting ready share business account. The second entry or the debit side is that of Rs. 2,46,600 which is conversion of investment shares into business. It may be stated that genuineness of this particular entry in the books of the assessee is not challenged by the Revenue at any stage and even before us the genuineness of this entry is not challenged. The entries in the books of accounts of the assessee were not challenged as device or a cloak to evade tax. Nowhere on the record the Revenue challenged that the entires did not reflect the real transaction between the parties. In the absence of any such challenge it is not open to the Revenue to contend before us that the transaction of conversion from investment to stock-in-trade for ready share business was not a permissible transaction. In the case of CIT vs. Amitbhai Gunvantbhai reported in (1981) 129 ITR 573 (Guj), the Division Bench of this Court has observed as under :
"The basic principle is the same in the law relating to income-tax as well as in Civil law, namely, that if there is no challenge to the transaction represented by the entires or to the genuineness of the entires, then it is not open to the other side - in this case the Revenue - to contend that that which is shown by the entries is not the real state of affairs."
We shall have, therefore, to accept the entry in the books of accounts of the assessee, dt. 9th November, 1961 as admissible piece of evidence for the purpose of establishing conversion of its investment shares into stock-in-trade for ready share business.
(e) The assessee has also produced letter addressed by it to the ITO, dt. 24th March, 1968. The said letter was written by the assessee to the ITO in connection with the particulars called for by the ITO from the assessee and in such letter full details including the details about the entry in the books of accounts were given by the assessee. In this letter the assessee also informed the ITO that it is not carrying on any purchase or sales of Arvind Mills and Atul Products shares from S.Y. 2012 to 2017. Its intention, however, was to make investment in shares. The dividend income thereof was assessed under the head "Other sources". It was also pointed out that said investment shares were converted into stock-in-trade in the beginning of S.Y. 2018 and it was urged that where capital investment is converted into stock-in-trade for business in ready share the cost price should be taken to the market price as prevailing on the date of conversion by specific reference to the decision of Supreme Court in the case of Bai Shirinbai (supra). This letter provides contemporaneous evidence of transaction of conversion of investment shares into stock-in-trade for business of ready shares. The genuineness of this letter is rightly not challenged at any stage by the Revenue.
(f) The third piece of evidence consists of various ankadas showing the subsequent conduct of the assessee while dealing with the aforesaid shares. Said ankadas produced at pages 216 to 248 of the paper book amply establish the fact that the delivery of aforesaid share certificates was effected to three brokers and that the brokers have in their turn on behalf of the assessee entered into number of transactions of sale and purchase thereby either requiring the assessee to make payment to the broker or entitling the assessee to receive payment from the brokers. According to the assessee the said three broker entered into transaction of purchase and sale as per the instructions because they had in their hands share certificates with duly filled in and signed shares transfer froms. The assessee, therefore, carried on business in ready shares of Atul Products and Arvind Mills Ltd. which would go to establish that the investment shares were converted into stock-in-trade for ready share business.
(g) Lastly, the assessee has also produced on pages 249 to 256 of the paper book ready share business account of S.Y. 2018 from the books of accounts of the assessee. Various transactions reflected by the ankadas referred to hereinabove were duly incorporated by the entries in this "ready share business account". The genuineness of this ready share business account is also not in dispute before us. From the aforesaid evidence which was also in existence before the Assessing Officer and other authorities it becomes clear that the transaction of conversion of investment shares as stock-in-trade on 9th November, 1961, i.e., the opening day of S.Y. 2018 was fully supported by evidence on record and following the decision recorded in the case of Bai Shirinbai Kooka (supra) the Tribunal was right in holding that the claim of the assessee that it converted investments in Atul Products and Arvind Mills shares as stock-in-trade on 9th November, 1961 being the opening day of S.Y. 2018 was supported by evidence on record.
(gg) Our attention was also invited to the unreported decision of the Division Bench of this Court in the case of Ansuyaben (Deceased) vs. CIT [IT Ref. 45 of 1972 decided on 22nd October, 1974]. Based on the decision in the case of Shirinbai Kooka (supra) the Division Bench of this Court tool the view that it is open to an assessee to convert his investment into an asset of business which the assessee may start and in such a case there is no question of a notional sale and for the purpose of computation of the profit from such assets converted into trading assets, the market value on the date of conversion, is a basis of determining the actual profits realised when such trading assets are sold. The Division Bench further held that for judging the character of such transaction (of conversion) of investment into trading asset) several factors are to be taken into account, such as magnitude of transaction of sale or purchase, the subsequent dealing of the assessee, the manner of disposal of assets or properties to ascertain as to whether they were of trading nature. The Division Bench also found that it is essential that there should be a business in existence of which the property could form the stock-in-trade. A business connotes, some real, substantial and systematic and organised course of activity carried by the assessee to show that he had desire to launch upon an adventure in the nature of trade. In our opinion, in the facts of the case before us the assessee was already dealing in shares by was of ready share business. So far as other activities were concerned, it was easy for him, therefore, to convert his investments in the aforesaid two scrips into stock-in-trade for ready share business. The aforesaid decision, therefore, does not, in any way, run counter to our conclusion.
(h) At this stage, we may also mention one submission made by Mr. K. C. Patel, learned advocate for assessee. In his submission, this Court should decline to answer question No. 1 inasmuch as it is purely a question of fact which the Court is not required to answer in its advisory jurisdiction. By reference to the aforesaid documentary evidence, he submitted before us that the conclusion was based by the Tribunal on some evidence on which conclusion could be arrived at, and, therefore, no question of law, as such, arises which calls for opinion of this Court. In the case of CIT vs. Orissa Corporation Pvt. Ltd. reported in (1986) 159 ITR 78 (SC), the Supreme Court confirmed the judgment of Orissa High Court which confirmed the action of the Tribunal in refusing to refer any statement of the case to the High Court. The Supreme Court found that the conclusions reached by the Tribunal were based on evidence. Such conclusions, therefore, cannot be said to be based on no evidence. Therefore, even if the High Court could have reached different conclusions on re-appreciation of evidence, it was not open to do to interfere with such conclusions which were reached by the Tribunal. The findings reached by the Tribunal cannot be said to be unreasonable, perverse or based on no evidence, and, therefore, according to Supreme Court, the High Court was justified in not calling for reference of question of law under s. 256(2) of the Act. In the case of CIT vs. Karamchand Thapar & Bros. P. Ltd. reported in (1989) 176 ITR 535 (SC), once again, in the context of powers of the High Court under s. 256 of the IT Act, 1961, the Supreme Court held that the Tribunal is the final fact finding body. The questions whether a particular loss is trading loss or capital loss and whether the loss is genuine or bogus are the preliminary questions to be determined on appreciation of facts. Findings of the Tribunal on these questions are not liable to be interfered with unless the Tribunal has taken into consideration any irrelevant material or has failed to take into consideration any relevant material or the conclusions arrived at by the Tribunal are perverse in the sense that no reasonable person, on the basis of the facts before the Tribunal, could have come to conclusion to which it has come.
(i) Very recently, in the case of CIT vs. Cellulose Products of India Ltd. reported in (1991) 192 ITR 155 (SC) the Supreme Court reiterated the law by stating that it is settled that the High Court hearing reference under IT Act does not exercise an appellate or revisional or supervisory jurisdiction over the Appellate Tribunal and that it acts in a purely advisory capacity. If the Tribunal, after considering the evidence produced before it on a question of fact, records its finding cannot be interfered with by the High Court unless such a finding was not supported by any evidence, was perverse or was patently unreasonable.
(j) Based on the above position of law, Mr. K. C. Patel, learned counsel for assessee, submitted that since there was more than sufficient evidence on record before the authorities to justify the conversion of investment shares into stock-in-trade for ready share business and since genuineness of such evidence was at no stage doubted there was sufficient material before the Tribunal to reach the findings which it has reached, and therefore, this Court should decline to answer question No. 1. In fact, we have already discussed hereinabove the evidence which was before the Tribunal, and we have independently come to the conclusion that the Tribunal was justified in recording the findings it has reached on evidence which was before it. Hence, we do not think it proper to decline to answer this question though we are of the opinion that the question No. 1 partially requires this Court to reappreciate the evidence and to record its findings as regards sufficiency or otherwise of the evidence for the purpose of reaching finding which was reached by the Tribunal.
(k) We, accordingly, answer question No. 1 in the affirmative, i.e., in favour of the assessee and against the Revenue.
5. Question No. 2 - Hedging transaction
(a) It is the case of the assessee that after converting investment shares in Atul Products and Arvind Mills Ltd. to stock-in-trade for business of ready shares it gave delivery of ready shares to three brokers with a view to hedging against loss in his holdings of stocks of shares through price fluctuations as permissible under clause (b) of sub-s. (5) of s. 43. It is the case of the assessee that against the hedging over the delivery of shares it carried on business of purchase and sales by handing over the delivery of said shares of Arvind Mills Ltd. and Atul Products to three brokers along with delivery of share certificates and duly filled in and signed share transfer froms. According to assessee it carried on business in ready shares of Atul Products and Arvind Mills Ltd., and, therefore, it was entitled to claim loss of Rs. 5,28,578 for the asst. yr. 1963-64 as allowable under s. 43(5)(b) of the IT Act, 1961, and on the same basis, the assessee had also claimed that it should be allowed loss for the asst. yr. 1964-65.
(b) Before, we proceed to discuss genuineness or otherwise of hedging transaction of the assessee, it would be proper to look at the provisions of the Act. Section 28 of the IT Act, 1961, inter alia, provides that incomes accumulated therein shall be chargeable to income-tax under the head "Profits and gains of business or profession". Explanation 2 to s. 28 being relevant is reproduced herein :
"Explanation 2 : Where speculative transactions carried on by an assessee are of such a nature as to constitute a business, the business (hereinafter referred to as 'speculation business') shall be deemed to be distinct and separate from any other business."
Section 43 is a statutory dictionary for certain terms relevant to income from profits and gains of business or profession. Section 43, inter alia, provides that unless the context otherwise requires in ss. 28 to 41 and in s. 43 "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 -
(b) a contract in respect of stocks and shares entered into by a dealer or investor therein to guard against loss in his holding and shares through price fluctuations;
shall not be deemed to be a speculative transaction"
We are, in this case, concerned with clause (b) of sub-s. (5) of s. 43.
(c) According to s. 43(5) of IT Act, "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 actual delivery or transfer of the commodity or scrips. Explanation 2 of s. 28 of the Act, 1961 enjoins that when an assessee enters into speculative transactions so as to constitute business, such business is deemed to be a distinct and separate business or any business of his. By s. 73(1) of the Act, 1961, it is enacted that any loss in respect of speculative business would not be set off except against profits and gains, if any, of another speculative business. In other words, the Legislature has, after carving out a subordinate sources of business income styled as speculative business, enjoined that this loss cannot be set-off against profits and gains, from any non-speculative transaction, though it may be part of the larger head of income of business or profession. In the income-tax law this new class of speculation business, as defined in s. 43(5) of the Act, 1961, as one more distinguishing feature than the one which is attributed to such transactions in the law of contract. The distinguishing feature is that the question of intention of seller or purchaser is not very material in the income-tax law, as it settled otherwise than by actual delivery, it would amount to speculative transaction. However, cls. (a), (b) and (c) of the proviso to s. 43(5) by legal fiction takes out of the purview of speculative transactions forward contracts effected with a view to guarding against the loss due to adverse price fluctuations. In speculative transactions the modus operandi of persons indulging in them is that when one enters into a contract of purchase, he also simulataneously enters into one or more contract of sale against the same quantity deliverable at the same time either to the original vendor or to some one else, so as either to secure profit or to minimise loss, before the vaida day; and similarly when he enters into a contract of sale, he simultaneously enters into one or more contracts to purchase the same quantity before the vaida day. The result of such dealings, when the sale and purchase are to and from the same person, has the effect of cancelling the contracts leaving only difference to be paid.
(d) The hedge contracts are those contracts which hedge against prejudicial price fluctuations. Hedging transactions are required to be distinguished from these speculative transactions. Hedging transactions are genuine transactions entered into for the purpose of insuring against adverse price fluctuations. In hedging transactions, neither delivery nor transfer is contemplated, and yet, they cannot be considered as speculative transactions in commercial parlance. By hedging transactions, a trader by corresponding contract of sale and purchase in the forward market tries top offset the likely loss which may arise in the ready market due to adverse price fluctuations.
(e) We may also refer to the decision of Full Bench of this Court in the case of Pankaj Oil Mill vs. CIT reported in (FB) (1978) 115 ITR 824 (Guj) (FB). In this case, in the context of s. 43(5), and more particularly, proviso (a) the court was required to decide the question as to whether the decision of the Division Bench of this Court in the case of Chimanlal Chhotalal vs. CIT reported in (1968) 69 ITR 129 (Guj) was rightly decided insofar as it restricted operation of hedging contracts covered by proviso (a) to a contract of purchase only of raw materials or merchandise. The Court held that the interpretation placed by the Division Bench in Chimanlal Chhotalal's case (supra) was not correct. On a true construction and effect of proviso (a) to s. 43(5) of the IT Act, 1961, every contract irrespective of whether it was sale or purchase of raw material or merchandise entered into by a person in the course of his manufacturing or merchandising business would not be deemed to be a speculative transaction if its purpose is to guard against the loss through future price fluctuation in respect of his contracts for actual delivery of goods manufactured by him or merchandise sold by him. While holding that the decision of the Division Bench in Chimanlal's case (supra) was not rightly decided, the Full Bench held that the hedging contracts in order to be out of speculative transactions must be in respect of only raw materials so far as the manufacturer is concerned though these contracts may be both with regard to sales and purchases. The Court also held that the hedging contracts need not succeed the contracts for sale and actual delivery of goods manufactured, but the latter may be subsequently entered into, provided they are within the reasonable time not exceeding generally the assessment year. The Court also held that in order to be genuine and valid hedging contracts of sales, the total of such transactions should not exceed the total of the raw materials or the merchandise on hand which would include existing stocks as well as the stocks acquired under the firm contracts of purchase.
(f) In the aforesaid case the Full Bench referred extensively to the technique of hedge trading as explained by well known economist, W. R. Natu in his book "Regulation of Forward Markets" at page 9 as under :
"The hedge contract is so called because it enables the persons dealing with the actual commodity to hedge themselves, i.e., to insure themselves agains adverse price fluctuations. A dealer or a merchant enters into a hedge contract when he sells or purchases a commodity in the forward market for delivery at a future date. His transaction in the forward market may correspond to a previous purchase or sale in the ready market or he may propose to cover it later by a corresponding transaction in the ready market, or he may offset it by a reverse transaction on the forward market itself.
To take an illustration, a merchant may go to the ready market and purchase cotton. He may purchase it for selling it again later to a mill for manufacturing it into cloth, in which case, he might hold it in his stock for a time, say, one month. If he buys the cotton at Rs. 800 per candy, and during the month, the price falls to Rs. 750 per candy, he would be making a loss of Rs. 50 per candy. He thus undertakes a risk when he buys cotton in the ready market and stocks it for a period of time, and naturally tries to find a way by which the risk can be reduced. He, therefore, goes to the forward market and sells cotton forward contract for delivery after one month, at say, Rs. 770 per candy. The purchase transaction in the forward market. At the end of one month, if the ready price has fallen by Rs. 50 he would be put to a loss in the ready market, when he offsets his original purchase by a sale in that market. At the same time, however, he would also be offsetting his original sale on the forward market generally follows the same trend as in the ready market, he would be purchasing in the forward market also at a lower price, perhaps at Rs. 720 per candy, making a profit of Rs. 50 per candy. He would thus make a profit on the forward market which would reduce or at times even more than wipe out the loss that he suffers on the ready market. In this way, he is able to reduce his risk and cut his losses by recourse to the forward market and might even in favourable circumstances end up with a profit on balance."
"Thus, by a resorting to counter balancing transactions in the market for the ready commodity on the one hand and in the hedge market on the other hand, the hedger seeks to safeguard his position. The movement of prices in the two markets may not always follow an identical course and the hedger might at times gain and at times lose but such a gain or loss would be marginal and far less than what it would be if the person had not hedged at all. While, however, the hedging operation protects the hedger against loss arising from adverse fluctuations in prices, it also prevents him from making windfall profit owing to favourable fluctuations in prices as well. The forgoing of such possible windfall profit is the price which he pays for the insurance against loss."
Having so quoted the technique of hedge trading as explained by W. R. Natu, the Full Bench observed as under :
"This well-known technique of hedge trading clearly implies forward contracts both ways, namely, for sale and purchase with a view to guarding against adverse price fluctuations. These forward contracts by way of hedge transactions usually afford a cover to a trader inasmuch as his loss in the ready market is offset by a profit in the forward market and vice versa. It, therefore, follows that in order to effectively hedge against adverse price fluctuations of the manufactured goods or merchandise, a manufacturer or merchant has necessarily to enter into forward transactions of sale and purchase both, and without these contracts of sale and purchase constituting hedge transactions, there would be no effective insurance against the risk of loss in the priced fluctuations of the commodity manufactured or the merchandise sold."
It becomes clear from the aforesaid quotations that hedging transactions are those transactions where person hedge themselves, i.e., insure themselves against adverse price fluctuations and proviso (b) to s. 43(5) clearly permits such transaction. In the absence of proviso (b) of s. 43(5) such transaction would have been speculative transaction. A dealer in stocks and shares can enter into a contract to guard against loss in his holdings of stocks and shares which may arise due to adverse price fluctuations. However, the only condition which should be satisfied before he can claim that a contract entered into by him should not be considered as a speculative transaction is that he must have entered into such a contract to guard against the loss due to adverse price fluctuations of shares in respect of which he might have entered into contract of sale by actual delivery. The Full Bench of this Court in this connection also referred to the decision of the Central Board of Revenue which has decided as under :
"Board's decision :
The intention has always been that where bona fide forward sales as entered into with a view to guarding against the risk of raw materials or merchandise in stock falling in value, the losses arising as a result of such forward sales should not be treated as speculation losses. Accordingly ITOs should not treat such transactions as speculative transactions within the meaning of Explanation 2 to s. 24. It is to be noted in this connection that hedging sale can be taken to be genuine only to the extent the total of such transactions does not exceed the total stocks of raw materials or merchandise in hand. If the forward sales exceed the ready stock, the loss arising from the excess transactions should be treated as loss arising from speculative transactions and not from genuine hedging transactions".
From the aforesaid decision of Board it becomes clear that in order to be genuine hedging transaction, the sale should be confined to the total stock of raw materials or merchandise in hand or of ready stock shares in possession. The forwarding sales should not exceed the ready stock. If the forward sales exceed the ready stock the transaction would be a speculative transaction, and not genuine hedging transaction. In other words, it is implicit that the hedging transaction in order to be out of speculative transaction must not exceed total stock-in-trade which would necessarily include existing stocks as well as firm contracts of purchase of stock-in-trade.
The Full Bench of this Court in the case of Pankaj Oil Mills (supra) also found that there should be reasonable nexus as to the time so as to enable a manufacturer or merchant to claim that his hedging transactions are not speculative transactions and the loss suffered thereunder be allowed to be set off against the profits and gains of any other business. What would be reasonable connection is always a question of fact depending on the circumstances of each case. Nevertheless, the second set of contracts, though may be subsequent in point of time to the first set, cannot be generally beyond the assessment year.
The Assessing Officer, therefore, shall have first to examine whether a hedge transaction is genuine or not by applying the aforesaid relevant factors. If it is genuine one, and it is by way of future sale of commodity against stock of the same commodity, the loss arising out of this transaction should be excluded from the purview of speculation.
(g) Keeping the aforesaid principles in mind, we may now proceed to examine the submission made by Mr. M. J. Thakore, learned counsel for the Revenue, that the transactions in question in the case before us are not hedging transactions. In his submission, in order to be genuine hedging transaction, there should be a spot purchase and forward sale or a spot sale and forward purchase and that said transaction must be so inter-connected that one is reflected in the other. However, this submission cannot be accepted as it stands counter to the nature of hedge transaction described by W. R. Natu in his book. The transaction of a person in the forward market may corresponding transaction in the ready market or he may offset it by a reverse transaction on the forward market itself. It is, thus, clear that a purchase transaction in the ready market can be counter-balanced by sale transaction in the forward market. It is, therefore, not essential that in order to be genuine hedge transaction there must be ready purchase and forward sale or ready sale and forward purchase.
(h) We may also mention that series of transactions entered into by the broker on behalf of the assessee have been reflected by various ankadas resulting into either payment by the broker to the assessee or by the assessee to the broker would show that they were coupled with delivery of the share certificates to the brokers. Firstly, the assessee has by posting entry into the books of accounts indicated his intention to transfer the aforesaid two scrips from investment account to ready share account. The ITO has not challenged the said entries as sham or bogus or as not bona fide entries. Secondly, the assessee has, thereafter, delivered his total holdings in the aforesaid two scrips to the brokers along with duly signed and filled in transfer forms. What the assessee had thereafter carried on are the hedging transactions to hedge against the said stock. Various entries made in the books of accounts of the assessee in supported of such hedging transactions were also not doubted by the ITO. True it is, that ultimately in such transaction loss is caused to the assessee and, therefore, he has claimed the said loss as hedging loss. Section 43(5) proviso (b) permits hedging in respect of stock-in-trade to guard against the fluctuations in prices. It is pertinent to note that the transactions connected with the purchase and sales of said shares which were settled by way of payment of dues ultimately did not exceed the total quantity of scrips handed over to the brokers, and therefore, genuineness or otherwise of said transaction cannot be doubted. We are, therefore, of the opinion that when the assessee had, as permitted by law under proviso (b) of s. 43(5) of the Act, entered into hedging transactions to hedge against the price fluctuation in the aforesaid two scrips, the assessee was entitled to claim hedging loss, and the Tribunal, in our opinion was right in upholding the claim of the assessee.
(i) Mr. M. J. Thakore, learned counsel for Revenue, has raised additional challenge in this reference and based on the decision of the Supreme Court in the case of McDowell & Co. Ltd. vs. CTO reported in (1985) 154 ITR 148 (SC) contended that the entire transaction beginning from conversion of investment shares into aforesaid two scrips to stock-in-trade for business of ready share and all subsequent hedging transactions by either payment or receipt of difference in price was nothing but colourable device with a view to avoid payment of tax and that this Court should not permit such colourable device. True it is, that in the said decision the Supreme Court has condemned the art of dodging tax without breaking the law. The Court has also pointed out that the distinction made between tax avoidance and tax evasion by the English Courts is now given a decent burial and judicial attitude towards tax avoidance has changed and the smile, cynical or even affectionate though it might have been at one time, has now frozen into a deep frown. Therefore, while broadly agreeing with the aforesaid with the aforesaid principles, we shall have to see as to whether in our advisory jurisdiction under s. 256 of the IT Act, 1961, we can permit the Revenue to raise such a question. Firstly, we are of the opinion that such a question does not directly arise from the questions of law referred to us for our opinion. It is also not permissible for us to call for such a question from the Tribunal because such a question does not arise out of the judgment of the Tribunal inasmuch as the Tribunal has factually found that conversion of investment shares into stock-in-trade for business of ready shares was effected on 9th November, 1961 as supported by entry in the books of accounts. The Tribunal has found that such conversion was permissible in view of the decision of the Supreme Court in the case of Bai Shirinbai Kooka (supra). The posting of entry in the books of accounts of the assessee was not doubted by the ITO at any stage. Therefore, in our opinion, the assessee acted within law in converting his investment shares into stock-in-trade for ready share business, and thereafter, the assessee entered into hedging transactions as permissible under proviso (b) to s. 43(5) of the Act. It will not be out of place to mention at this stage that the ITO has verified the genuineness or otherwise of the hedging transactions by cross checking the accounts books of the brokers and by tallying their accounts with the accounts of the assessee. The ITO, therefore, did not and could not doubt the genuineness or otherwise of the hedging transactions which ultimately resulted into business loss to the assessee. It is also found that the assessee has given delivery of the share certificates to the brokers along with duly signed and filled in transfer forms of the said two scrips. It is also found that at no point of time the hedging transactions exceeded the stock of the assessee in the aforesaid two scrips, and therefore, the genuineness or otherwise of the transactions could not be challenged by the ITO and the Tribunal based on the aforesaid findings reached the conclusion that the hedging transactions were permissible in law and the assessee was entitled to claim loss. It cannot, therefore, be said that the entire transaction was a deviced to evade the payment of tax. In fact none of the authorities have found this transaction of hedging to be a device or preplanned scheme. We, therefore, do not permit Mr. Thakore, learned counsel for the Revenue, to agitate this question, for the first time, before, us especially, on the facts found by the three authorities it is not permissible to record a finding that the entire transaction was a colourable device to evade tax.
(j) Mr. M. J. Thakore also invited out attention to the decision of this Court in the case of CIT vs. Smt. Minal Ramesh Chandra reported in (1987) 167 ITR 507 (Guj) where the Court found that the device has been adopted to evade tax, and, therefore, the Court was entitled to unravel the device. The Court held that the Court must examine the substance of the transaction and then decide whether the transaction is such that judicial process may accord approval to it. The Court also found that there was no evidence in support of transaction excepting an entry entered into the books of accounts of the assessee to show that the land was converted into stock-in-trade. On evidence, the Court found that the entry in the books of accounts was not a genuine entry and that the entries in the books of accounts were not contemporaneous. The Court also found that the question regarding the device to avoid tax did arise before the Tribunal and in fact the Commissioner has held that the assessee has adopted the device to avoid the tax. In the aforesaid factual situation the Division Bench of this Court applied the ratio of the decision in the case of McDowell (supra). In our opinion, the aforesaid decision is based purely on facts contained before the Division bench of this Court where before the AAC the clear finding was reached on evidence that the assessee had adopted device to avoid tax. The Tribunal did not scrutinise the entire transaction in greater detail whichs called for interference by this Court. However, in the facts and circumstances which obtained before us it is found that at no stage the ITO had doubted the entries in the books of accounts as sham or bogus and/or not bona fide ones as well as the subsequent hedging transactions. On the contrary, the ITO has verified all the hedging transactions by cross-checking the books of accounts of various brokers and has found that the transactions should be genuine. In that view of the matter, independently, we have also examined the entries in various transactions and we do not find that the entire transaction was a device to avoid tax. We, therefore, do not permit the Revenue to raise this new submission.
(k) In the result, we answer the question No. 2 in the affirmative, i.e., in favour of the assessee and against the Revenue.
6. Question No. 3 :
(i) As stated hereinabove, while stating the facts giving rise to the present reference, against the judgment and order of the CIT in second appeal preferred to the Tribunal, the Tribunal decided by its judgment, dt. 11th September, 1972 that the CIT was not right in holding that the assessee was liable to tax on the capital gains as a consequence of sale of said shares. However, it is required to be noted that the original order of assessment passed by the ITO were subject to appeals preferred by the assessee which were pending before the AAC. During the pendency of said appeals the CIT exercised power under s. 263 of the Act and it was the said decision of the CIT which was challenged before the Tribunal. While dealing with said appeal the Tribunal in its para 3 of the judgment noticed that the claim of the assessee that the investment shares were converted into stock-in-trade in the relevant year was not within the scope of the appeals before it. In fact, against the finding reached by the ITO in not upholding said claim of the assessee, the appeals of the assessee were pending before the AAC, and they were subsequently disposed of. The assessee has, thereafter, moved the AAC to decide the questions which were not answered by the AAC. The Tribunal has, however, recorded in para 7 of its judgment a finding that surplus arising out of Arvind Mills and Atul Products shares should be treated as capital gains as has been rightly held by the ITO. Based on this finding of the Tribunal in the earlier appeal it was contended before the Tribunal by the Revenue that the subsequent appeals against the order of the AAC were not maintainable because this ground was already concluded by the Tribunal in its earlier order in ITA Nos. 225 & 226 (Ahd)/1970-71. The Tribunal, while dealing with said preliminary objection, rightly found that while deciding the earlier appeals, the Tribunal has not actually gone into the question of conversion of investment shares into stock-in-trade for ready share business. It is, no doubt, true that the observations made by the Tribunal in para 3 of its earlier judgment are inconsistent with the observations made in para 7 of its judgment. After going through the earlier judgment of the Tribunal, we are of the opinion that the Tribunal has on the earlier occasion not decided the question of conversion of investment shares into stock-in-trade for ready share business and in fact the observations made by the Tribunal in para 7 of its judgment while deciding earlier appeals were subject to the appeals preferred by the assessee before the AAC. In our opinion, therefore, the Tribunal was right in entertaining the appeals of the assessee on merits, and in rejecting the preliminary objection raised by the Revenue.
(ii) In the result, we answer question No. 3 in the affirmative, i.e., in favour of the assessee and against the Revenue. No costs.