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MUMBAI. Vide a recent landmark ruling; AIT-2006-105-ITAT ITAT has ruled that the  amount on sale of shares , by the lender, of the shares owned by the assessee but pledged to the lender does not constitute capital gain exigible to tax in assessee’s hand because  no   value of the consideration was  either    received  or   accrued  as a  result of the   transfer of  those     shares. 

T H E  F A C T S:

The   assessee was  a  finance  company  and  during  the year  it   received  income  from  interest, dividend  and   capital  gains.  During  the course of   assessment  proceedings  the  AO  noted that      there  was a  sale of  11,72,900  shares of  NIIT  Ltd.    Sale of  these  shares   resulted in  a  capital  gain   after  allowing  indexation   of the  cost of   acquisition  amounting to Rs.  29,06,97,940/-.  The    assessee,   however,  did  not  offer   this  capital gain for  assessment.   According to the  assessee,  sale of  these  shares  in  view of  the  guarantee  given  by the  assessee  for  loan  taken  by  another  company,  did  not  result in  any income   to  the  assessee.   The    assessee  did  not   receive  any  money   from the  sale of  these  shares.   Under  the provisions of   section  45(1) “any  profits or  gains  arising  from   transfer of  capital   asset”   were  chargeable to  income-tax.   In  the   case of  the  assessee   there  was  no  profit or  gains  arising  to  the   assessee.    

The AO  held  that  a  plain   reading of   section  45(1) of  the Act  talked  about  profits or  gains  arising    from  transfer of  a  capital   asset.    It  did  not  talk  about  money    received or    receivable  and   how  the  gains  arising  from  the  transfer of  capital  asset  were  utilized.  Provisions of   section 2(47)   gave  a   wide  ranging  definition of  “transfer”.   In  the    assessee’s   case   certain   shares  belonging to  the  assessee  had  been    voluntarily  pledged  by  the  assessee  with certain  credit  institutions  to  help  another  company  to  raise  loans.    When  the   assessee  company  pledged   the  shares, it  was  understood   that  in  case of   default  the  creditor  shall  have  the  right to    sell  the  shares  to  recover  his  dues.   Hence  it  was  immaterial   that  the   assessee  himself  had  not  sold  the  shares  but  the  shares  had  been  sold  on   assessee’s  behalf   by  the  creditor  with  whom  the  shares had  been  pledged  by  the   assessee.   Since  the   shares  had  been  sold   capital  gain   had  arisen.   The  consideration  for the   transfer  ultimately  seemed to  have  been   received  by the   debtor    on  whose  behalf  the   assessee  had  given the guarantee.  The  debtor   whose   debts  had  been  discharged   by  sale of  these   shares  was, in    law,   a debtor  to  the  assessee   for  the  amount of  consideration.   That  being  so  the   assessee’s  contention  that it    did  not   receive  any   consideration   on  account of   transfer  had to  be  rejected.  The   assessee  could  not   say  that  no  consideration  had  been   received  just  because  some  body  else  had   received  the  consideration  on  his  behalf and  who  was  then  legally    asessee’s  debtor  who  could  be  enforced in  law.    Hence,  in  a  way   the   assessee  had  exchanged  his  shares  for  a  debt owed    by the company  on   whose  behalf  the   assessee  had  given  the guarantee.  AO  held that     discharge of  mortgaged   debts  by the  sale of   shares  of  the  assessee    did not  constitute   a  diversion  of  the  sale  consideration   at  source  and  that  the  debt  discharged  by  the    sale of  shares     could  not  be  said to  have  enhanced   the  rights of  the   assessee  in  those  shares,  so   as to  constitute   increase  in  the  cost of    acquisition of the  shares  to  the   assessee.  The AO  further    held that  the   assessee’s   liability  to  pay  tax  could  not  be   neutralized  by   any   agreement   entered  into  for  charges   created   against   the   shares  voluntarily.    The  bank or  any other  person  did  not  have  any  overriding  title   to  the   receipt.          The AO   held that   capital  gain    tax  was clearly    leviable  on the      assessee  and  any   agreement  as  to  mode of  utilization    of  the  gain  arising  from the   transfer of  any  capital  asset  could  not   affect   the  liability   as to  the charge of  tax on the   assessee.  AO   assessed  a sum of Rs.  29,06,97,940/-  as  capital  gain  arising  to the   assessee on  sale of  11,72,900  shares of  NIIT  Ltd.

The   CIT(Appeals)  held that   sale  proceeds  of  NIIT  shares    received by  the  lender  did  not  constitute capital  gain  exigible to   tax in  the    assessee’s  hands.   Aggrieved  by this  order    revenue was  in  appeal  before  Tribunal.

T H E   R U L I N G:

·         The  assessee  had  already    handed  over   share   certificates   in  original  along    with   duly  signed  bank   transfer   deeds  to  the  credit   institutions.  Thus,   the   assessee   had  already    completed  his  part of   transfer   at  the  time of the  pledge   of the   shares and     in the  event  of the  failure on the  part of   Pertech and  Swati    the  credit   institutions  could   freely    sell   the    shares in the  open  market.  

·         What  appears to  us  to be  clinching   the  issue is  the   fact that  the   assessee  before   us  has  not   received  a  single  paisa    from  out of   sale  proceeds   of  the   assessee’s    shares  running     into  crores of  rupees.  

·         The    assessee was  even  entitled to  throw  these   shares  from  the  window  of  a  running    train  if  he  so  wished because  he  was  absolute  owner of  these  shares.  In the  case before  us  there is  not  even  a  whisper of  any  advantage  received  by the   assessee.   On  the   facts of the  case  as    they  have  emerged  before  us  the  only  possible  inference  is that  the   assessee   made a  kind of  gift  of  these   shares  in  favour of  Pertech and  Swati. 

·         There is  no  authority  in  law  to  tax,   in  the  absence  of  any  under-statement of  consideration  or    colourable  device,  to  charge  capital gains  on an  amount  not   actually   received  by or   accrued to  the   assessee.   We  see  no  difficulty  in   arriving  at  the conclusion that   under    the provisions  of  section  45  an  assessee  cannot  be   charged   to  tax  in  relation to  an  amount other  than  the  amount   actually   received  by or accruing to him  as consideration for   transfer.  The provisions of   section  45   bring to   charge   of   tax, “any  profits  or  gains   arising  from   the   transfer  of  a  capital   asset”.    The  levy  is  only  if  profits  or  gains   arise  to   the   assessee,     not  otherwise.   This   aspect is  made  very   clear    by  the provisions   of  section  48  which  lay down  for the purpose of  computation of  the income chargeable  under  the  head  “Capital gains”   certain   deductions  to  be  made  from  “the full   value of  the   consideration   received or   accruing   as a  result  of  the    transfer  of  the  capital    asset”.   The   revenue   has to  establish  that  certain consideration  was  either    received   or   accrued to the   assessee in  whose  hands   income  under  the  head  “Capital gains”  is   sought to be    assessed.

·         In the   case of CIT Vs. George  Henderson & Co. Ltd. AIT-1967-01-SC the Hon'ble  Supreme Court  have   stated  this   position in the following  words:-

         “For the reasons already stated, we are of the opinion that the expression " full value of the consideration " cannot be construed as the market value but as the price bargained for by the parties to the sale. The dictionary meaning of the word " full " is " whole or entire, or complete " (Shorter Oxford English Dictionary). The word " full " has been used in this section in contrast to " a part of the price ". Consequently, the words " full price " mean " the whole price ". Clause (2) of section 12B itself clearly suggests that if no deductions are made as mentioned in sub clause (ii) thereof, then that amount represents the full value of the consideration or the full price. In other words, when deductions are made as specified in sub clauses (i) and (ii), then that amount does not represent the full value. The expression " full value " means the whole price without any deduction whatsoever and it cannot refer to the adequacy or inadequacy of the price bargained for. Nor has it any necessary reference to the market value of the capital asset which is the subject matter of the transfer.

·         In the   case of  K.P. Verghese Vs. ITO, AIT-1981-03-SCit  has  clearly  been  held that  the  burden   to  prove  understatement of  the   consideration is  on  revenue.  Their  Lordships  have observed:

“It is well settled rule of law that the onus of establishing that the conditions of taxability are fulfilled is always on the revenue and the second condition being as much a condition of taxability as the first, the burden lies on the revenue to show that there is an understatement of the consideration and the second condition is fulfilled. Moreover, to throw the burden of showing that there is no understatement of the consideration, on the assessee would be to cast an almost impossible burden upon him to establish a negative, namely, that he did not receive any consideration beyond that declared by him.”

·         It is   argued  that    credit    institutions  sold  the   shares in  question on  behalf of  the   assessee and the  sale proceeds   were   applied in discharge of  debts  owed  to the  credit  institutions  by  Pertech  and Swati  on  behalf of   the  assessee.  We  do  not   see  any  basis  for  these    arguments of  the  revenue.   It is  not  the   case of the   revenue  that  the   assessee  sold  the  shares  belonging to  him  first  and   deposited  sale  proceeds   with the    credit  institutions   as   security.   What  the     assessee    parted   with  and  entirely  for  the  benefit  of  Pertech  & Swati,    were  the  share   certificates  themselves.  The   assessee  had  at  that  stage  completed  his   part of  the   transferor  and it  was  open to  anybody  to  insert  his  name  as  transferee  and  claim  the  ownership of the  shares  in  question.  If  at  all  the   assessee  applied  anything   for the  benefit  of  Pertech & Swati, it  was   the  share   certificates  themselves  and  not  sale  proceeds   of the  share  certificates.   Credit   institutions  subsequently   sold  these    shares  in  the  open  market  not  on  behalf   of  the   assessee  but on  behalf of    Pertech & Swati.  By  appropriation  of  the  sale  proceeds  by  the   credit   institutions, it  is  the  liability of   Pertech &  Swati  that  was  discharged  and  no  consideration  was   either    received or    accrued to  the   assessee   before  us.  On   these   facts   it is  difficult to   say  how  capital  gains  liability   is   attracted   in the  hands of  the   assessee  before  us.   As  early  as in the   case of Raja  Bejoy Singh  Dhudhuria  AIT-1933-01-PC  ,   the Hon'ble   Privy Council  have  held  as  under:-

“When the Act by s. 3 subjects to charge " all income " of an individual, it is what reaches the individual as income which it is intended to charge. In the present case the decree of the court by charging the appellant's whole resources with a specific payment to his step mother has to that extent diverted his income from him and has directed it to his step mother ; to that extent what he receives for her is not his income. It is not a case of the application by the appellant of part of his income in a particular way, it is rather the allocation of a sum out of his revenue before it becomes income in his hands.”

·         Profits  or   gains   arising   from the  sale of  11,72,900  shares of  NIIT Ltd.  in question  cannot  be    charged  to  tax in  the  hands of the   assessee  before   us  because  no   value of the consideration was  either    received  or   accrued  as a  result of the   transfer of  those     shares.  Moreover, even if  notionally any   consideration  on  sale of    transfer   accrued  to  the    assessee,  there   was  diversion of the  entire  consideration at  source  before it  became   income in  the  hands of  the   assessee. 

( Click here for full Text of ruling AIT-2006-105-ITAT )