Full Judgment
2. The assessee is a firm. The partners of the firm along with two other groups of persons, who could be described as the Dadia Group and Parekh Group, floated a company called Vishal Electronics (P.) Ltd. Initially the individual partners were the shareholders. For the purpose of circulating capital of this company, the assessee-firm had advanced certain funds. These advances date back to 1973. The company had been crediting the assessee's loan account with interest.
3. This company never did well. In fact, by 1977, their accumulated losses were of Rs. 10 lakhs as against the capital of Rs. 18 lakhs. He had never declared any dividend. By 3-3-1977, the company owed the assessee Rs. 2,80,000 and odd.
4. On 29-12-1977, the company purported to issue fresh shares and the credit balance standing in the name of the assessee was treated as the payments to be effected towards the acquisition of these shares. Thus, the assessee was allotted 2,800 shares of the face value of Rs. 100 each and the credit balance of Rs. 2,80,000 got wiped off.
5. Four months later, these shares were sold to another group at Rs. 5 per share, thus, suffering a loss of Rs. 95 per share. This loss amounting to Rs. 2,66,000 was claimed as short-term capital loss in the assessment for the assessment year 1979-80.
6. The assessing authority did not accept the assessee's contention. He found that prior to December 1977, the shareholding by the partners of the assessee-firm were a few shares only. At no point of time was any claim made that the shares were being held on behalf of the firm. The only time when such claim was made before him was in respect of the major transaction of 2,800 shares. According to him, it was a sham transaction. He stated that book entries have been passed for mutual accommodation between the Parekh Group and the assessee-firm. The assessee had never held any shares at any stage before the transaction.
There was no obligation on the assessec to take any of these shares.
He, therefore, disallowed the claim.
7. The Commissioner (Appeals) agreed with the assessing authority.
Referring to the acquisition of shares in December, 1977 and its disposal four months later, he pointed out that the assessee knew that the value of the equity shares as on the date of acquisition was nil and the value on the date of sale was also nil. There was no circumstances, which compelled the assessee to buy shares of nil value at Rs. 100 each and then to make a distress sale of the same at a mere value of Rs. 5 per share within four months. The assessee fully knew that the shares of the company were worthless and that it was continuously running into loss and it was in the best interest of the assessee to retrieve whatever it could out of the loan amount instead of going in four further advances ; that the assessee was fully aware of the situation was clearly proved by the fact that immediately within four months of the acquisition the assessee sold these shares at a nominal value.
8. The assessee is on further appeal before us. Shri Anil Harish, appearing for the assessee, submitted that the inferences drawn by the Commissioner (Appeals) from the material evidences of the case are erroneous. He pointed out that one of the partners of the assessee-firm was Vasant P. Shah, who was also a director in that company. Due to changed circumstances in the constitution of the assessee-firm in March 1977, Vasant Shah was required to devote considerable time to the business of the assessee-firm. Since the company was not doing well, it was decided that the members of the other group, i.e., Parekh and Dadia Group should relieve Vasant Shah as the director of the company.
Further, the partners of the assessee-firm felt that the firm's continued association with the company was not desirable. As mutually agreed upon by the three groups, it was decided to issue new shares of the company and these new shares were to be taken up by the three groups. Therefore, the assessee had to take up 2,800 shares on 6-1-1978. Since a limited company cannot issue shares either at premium or at discount, the assessee had to pay Rs. 2,80,000. He further submitted that the sale of these shares at a later point of time had not been challenged and the shares in fact have been transferred to the nominees of the Parekh Group. Therefore, the factum of purchase and the factum of sale have been proved and the loss arising therefrom must be allowed.
9. We are unable to agree. It is quite clear that the purchase of the shares in January 1978 was a device to convert the dues on the loan given to the company into a different asset, which could be shown to be disposed of land a capital loss claimed. The assessee does not have a business of financiers. It was, therefore, not possible for them to show that the advances made to the company were in the course of financing business. It could be considered only as an investment to earn interest. As a matter of fact, they did earn interest therefrom which had been subjected to tax in the years. It is an accepted position that the company has completely depleted their paid-up capital and their carried forward loss was about Rs. 10 lakhs. Such a company will never be able to pay back the principal or interest to the assessee.
10. There had been some change in the composition of the company and it appears that among the three groups, who controlled the company, it was decided that one group will take over and the other two groups will leave the company. Considering the acute financial position, the two groups, who will pull out of the company, could never have seen the colour of their money. It will be a bad investment for them. If they merely write it off, they would not get any reduction in the income-tax assessments.
11. It is in this background that the question of issue of further shares in December 1977/January 1978 to be considered. By that time it was already decided that one group will take over the company and the other two groups will pull out. In their letter to the Commissioner (Appeals) dated 8-12-1982, the assessee had stated that the assessee-firm had a major shake up in the accounting year 1976-77. The factory of the assessee was with the Court Receiver and ultimately in the month of March 1977, settlements took place between the two groups in the assessee-firm. It was decided that their partner Vasant Shah should devote more time to the firm's business and not to the business of the company. If this had taken place in March 1977, then it is inexplicable how in December 1977 and January 1978 they decided to acquire 2,800 more shares in the company. Under these circumstances, the application for the allotment of the shares made by the assessee on 28-12-1977 and the letter of the company dated 29-12-1977 allotting shares and the actual allotment of shares took place on 7-1-1978 have to be considered as a part of the device for converting an ordinary loan into shares.
12. When these shares are sold at a nominal value of Rs. 5 per share, later, the assessee could claim that there is a short-term capital loss. Now the Supreme Court in the case of McDowell & Co. Ltd. v. CTO [1985] 154 ITR 148 had stated that whereas tax planning made 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 plea that it is honourable to avoid the payment of tax by dubious methods. At p. 160, the Supreme Court observed 'in our view, the proper way to consider a taxing statute while considering a device to avoid tax is not to ask whether the provisions should be construed literally or liberally, nor whether the transaction is not unreal and not prohibited by the statutes, but whether a transaction is a device to avoid tax and whether the transaction is such that judicial process may accord its approval to it. We have to apply the above dictum to the facts of this case. As pointed out by the assessing authority and the Commissioner (Appeals) there was no compulsion in December 1977/January 1978 for the assessee to acquire another 2,800 shares in the company.
When there was no such compulsion and the assessee had actually purchased these shares, then it is reasonable to assume that there was an oblique motive behind it. It was quite clear when the shares were sold four months later at a nominal price of Rs. 5 per share that the tax benefit available by converting the loans into shares was the main objective. Even if the purchase and sale are true enough and real enough, in view of the fact that they are all part of a device, it will be difficult for judicial process to accord its approval to it.