1. These two appeals are filed by two companies M/s. KNB Investments (P.) Ltd. (ITA No. 189/Hyd./99) and M/s. KAR Investments (P.) Ltd. (ITA 190/Hyd./99). In both the appeals, the assessment year involved is the same, viz. 1995-96. These two companies have since been dissolved and merged into another group company, M/s. Dr. Reddy's Holdings Ltd. on the basis of a scheme of amalgamation, sanctioned by the Hon'ble High Court of Andhra Pradesh, vide their order dated 28-4-1995 and delivered while disposing Company Petition Nos. 1 and 2 of 1995. These appeals have been, in fact, filed by M/s. Dr. Reddy's Holdings Ltd. as successor to M/s. KNB Investments (P.) Ltd. and M/s. KAR Investments (P.) Ltd. 2. These appeals are filed against the orders of the CIT(A)-III, Hyderabad, dated 19-3-1999 and arise out of the regular assessments completed on the appellant-companies, for the assessment year 1995-96.
The assessments have been completed by the Asstt. Commissioner of I.T., Company Circle-4(5), Hyderabad, vide her separate proceedings under Section 143(3) of the Income-tax Act, 1961, dated 27-3-1998. M/s. KNB Investments (P.) Ltd. has returned an income of Rs. 15,73,540 and M/s.
KAR Investments (P.) Ltd. has returned an income of Rs. 23,63,720. The Assessing Officer made additions of Rs. 32,85,00,000 in the case of the former and Rs. 29,70,73,500 in the case of the latter and determined a total and taxable income of Rs. 33,00,73,540 and Rs. 29,94,37,220 respectively. It is against the above additions that the appellant-companies have preferred these second appeals before the Tribunal, as the first appeals were dismissed, and the additions confirmed by the learned CIT(A).
3. Dr. Reddy's Laboratories Ltd. is a company in which the appellant-companies have substantial investments as shares in the capital. The said company had made a preferential allotment of equity shares to the appellant-companies in the previous year relevant to the assessment year under appeal. M/s. KNB Investments (P.) Ltd. was allotted 9,00,000 shares and M/s. KAR Investments (P.) Ltd. was allotted 8,13,900 shares. The preferential allotment was made at Rs. 90 per share while the market price was Rs. 455 per share. The Assessing Officer treated the differential 'price of Rs. 365 per share as benefits arising from business in the hands of the appellant-companies, and brought the same to tax holding it as income under Section 28(iv) of the Income-tax Act, 1961. The disputed additions have been made on this ground.
4. In both the cases in appeal before us, the issue is the same, that the addition of income made under Section 28(iv) of the Income-tax Act under the same set of facts and circumstances. Accordingly, both the appeals arc considered together for analogous disposal. The only issue to be considered in these appeals is whether the Income-tax Department is right in holding that the differential price availed by the appellant-companies in acquiring the equity shares in the capital of M/s. Dr. Reddy's Laboratories Ltd., through a preferential allotment, is income of the appellant companies within the meaning of Section 28(iv) of the Income-tax Act, 1961 as "benefit arising from business".
5. These two companies were part of a closely held group of companies, inter alia consisting of M/s. Dr. Reddy's Laboratories Ltd., M/s.
Cheminor Drugs Ltd., M/s. Globe Organics Ltd., etc. Of course, the places of M/s. KNB Investments (P.) Ltd. and M/s. KAR Investments (P.) Ltd. have now been substituted by M/s. Dr. Reddy's Holdings Ltd., since the amalgamation and merger. M/s. Dr. Reddy's Laboratories Ltd. is the flagship company of the group. Dr. K. Anji Reddy is the Chairman of M/s. Dr. Reddy's Laboratories Ltd. He is a director in all other group companies and also the Chairman of few of them, including the two appellant-companies. The majority shareholdings in all the group companies are held by Dr. K. Anji Reddy, his family members and close associates. The main objects of the two appellant companies are to carry on the business of investment and particularly to acquire and hold stocks and shares, to promote and organise subsidiaries, syndicates and to deal in stock and shares, etc. Except for a token investment in IFCI Bonds, the entire investments of these two companies have been made in acquiring the shares of group companies, viz. M/s.
Dr. Reddy's Laboratories Ltd., Cheminor Drugs Ltd., Standard Equity Fund Ltd., Globe Organics Ltd., Diana Hotels, etc.
6. Dr. Reddy's Laboratories Ltd. convened an Extraordinary General meeting on 16-3-1994 to consider and pass certain important resolutions regarding matters tike increasing the authorised share capital of that company, issue of bonus shares, issue of shares in international market for tapping NRI sources and named as Euro-issue for a sum not exceeding 75-million US Dollars and also among other things to offer shares of the company to its promoters. And in the matter of offering shares to its promoters, a special resolution was passed to offer and allot 22,50,000 Equity Shares of Rs. 10 each at a premium of Rs. 80 per share to the 'promoters group' consisting of Dr. Anji Reddy, Shri M.P. Chary, their family members and relatives, companies, trusts, AOPs formed or controlled by them.
7. On the basis of the above decision, the Board of Directors of Dr.
Reddy's Laboratories Ltd., offered allotment of equity shares to the appellant-companies through their letters dated 25-4-1994. M/s. KNB Investments (P.) Ltd. made an application for 9,00,000 equity shares on 7-5-1994 and paid Rs. 90 lakhs as application money @ Rs. 10 per share.
M/s. KAR Investments (P.) Ltd. also applied for 8,13,900 equity shares on 9-5-1994 and paid Rs. 81.39 lakhs as application money at Rs. 10 per share. Dr. Reddy's Laboratories Ltd., vide their allotment letters dated 10-5-1994, allotted the entire shares applied for to the two companies, M/s. KNB and M/s. KAR. In the case of M/s. KNB Investments (P.) Ltd., the total amount payable was Rs. 8,10,00,000 and out of it Rs. 90,00,000 was paid at the time of application. The balance amount of Rs. 7,20,00,000 was directed to be paid as follows- In the case of M/s. KAR Investments (P.) Ltd., the total amount payable was Rs. 7,32,51,000 out of which Rs. 81,39,000 was paid at the time of application. The balance amount of Rs. 6,51,12,000 was directed to be paid as follows- 8. The acquisition of shares through the above preferential allotment has been reflected in the Balance-Sheets of the two appellant-companies as on 31-3-1995 as investments in the shares of Dr. Reddy's Laboratories Ltd. We are concerned with the assessment year 1995-96 for which the relevant previous year is 1994-95. While examining the accounts of the appellant-companies in the course of assessments under Section 143(3) of the Income-tax Act, 1961, the acquisition of shares on preferential allotment caught the special attention of the Assessing Officer. She found that the shares of Dr. Reddy's Laboratories Ltd. were quoted in Hyderabad Stock Exchange at Rs. 455 per share at the time of share applications made by the appellant-companies, whereas the preferential allotment of shares were made to the appellant-companies at Rs. 90 per share. She found that there is a difference of Rs. 365 between the quoted market price and preferential allotment price of a share. On a detailed examination of the facts and circumstances of the case, she came to a finding that the appellant-companies have derived benefits of Rs. 365 per share in the deal of preferential allotment; and that those benefits arose from business carried on by the companies. As the benefits have arisen from the business carried on by the appellant-companies, the Assessing Officer held that the value of that benefit has to be treated as income liable to tax under Section 28(iv) of the Income-tax Act, 1961.
9. The differential price per share was Rs. 365. M/s. KNB Investments (P.) Ltd. has acquired 9,00,000 shares. Therefore, the total value of the benefits would be Rs. 32,85,00,000. Likewise M/s. KAR Investments (P.) Ltd. has acquired 8,13,900 shares and the benefits would be of Rs. 29,70,73,500. Accordingly, the Assessing Officer proposed an addition of income Rs. 32,85,00,000 in the assessment of M/s. KNB Investments (P.) Ltd. and 10. The appellant-companies filed detailed objections to the propositions made by the Assessing Officer through their letter dated 12-3-1998. The objections run as follows- 1. The special resolution authorising preferential allotment of shares was passed on 16-3-1994 which fell in the previous year 1993-94 and therefore, the issue has to be considered for the assessment year 1994-95 rather than proposed for the assessment year 1995-96. Reliance placed on Abbot v. Philbin (Inspector of Taxes) [ 1962] 44 ITR 144 (HL).
2. What would be chargeable to tax under Section 28 would be an income, i.e. receipt on revenue account. The issue of equity shares on preferential basis to the promoters would be on capital account and not on revenue account and as such it cannot be brought to tax under Section 28 of the Income-tax Act.
3. The provisions of Section 28(iv) provide that the benefit must be arising from business so as to treat its value as income. In the appellants' cases, they neither carried on any business nor received any benefit.
4. The words 'arising from business' implies that any receipt from trade or from an adventure in the nature of trade should be regarded as income and assessable to tax is explained by the Patna High Court in Bisheshwar Singh v. CIT[1955] 27 ITR 376. In the case of appellants no business was carried on by them and the income considered of dividend and interest from investments to be assessed under 'Income from other sources'.
5. There is no nexus between the business of the appellants and the benefits derived by them, so that the benefits do not become income.
Reliance placed on CIT v. Bhavnagar Bone & Fertiliser Co. Ltd. [1987] 166 ITR 316 (Guj.) and CIT\. General Electrodes & Equipments Ltd. [1985] 155 ITR 78 (Bom.) 6. The profit on acquisition of shares made not for the purposes of dealing in them, would be on capital account and therefore, could not be treated as income. Reliance placed on Ramnarain Sons (P.) Ltd. v. CIT [1961] 41 ITR 534 (SC), Kishan Prasad & Co. Ltd. v. CIT [1955] 27 ITR 49 (SC) and CITv. National Finance Ltd. [1962] 44 ITR 788 (SC).
7. Every benefit is not taxable. Mere relief in expenses is not income. The reduction in the capital cost cannot be treated as income. Reliance placed on Acharya D.V. Pande v. CIT [1965] 56 ITR 152 (Guj).
8. If the proposition of the Assessing Officer is to be accepted then the benefits arising to shareholders and directors in the Rights issue of shares by a company would be treated as income and brought to tax which is against the legislative intention discussed in CBDT Circular No., 710, dated 24-7-1995, 11. The Assessing Officer considered all the above objections in detail, but declined to accept them for the following reasons : 1. In Abbot's case (supra) cited by the appellants, it was held that the tax-payer should be assessed in respect of the year when the option to purchase shares was given. In the present case, in pursuance to their resolution dated 16-3-1994, Dr. Reddy's Laboratories Ltd. made the offer to exercise the option on 25-4-1994 as evident from the copy of share application marked as Annexure 'G' to the assessment order. The Companies made the applications on 17-5-1994 and 9-5-1994. Shares were allotted on 10-5-1994. All the events have taken place in the financial year 1994-95 which is the previous year relevant to the assessment year 1995-96. Therefore, the issue of taxability has been rightly considered for the assessment year 1995-96.
2. The benefits have been derived by the appellant-companies in the course of their business of investment. It is revenue in nature and therefore, taxable. The same items may be capital asset in one hand and the receipt of the same may be on revenue account in the other hand. It was held that shares allotted to a director of a company pursuant to agreement between promoters is a benefit assessable to tax - D.M. Neterwalla v. CIT [1980] 122 ITR 880 (Bom.). Reliance also placed on Amarendra Nath Chakraborty v. CIT[1971] 79 ITR 342 (Cal), wherein it was held that the value of the gift of land was a receipt by the assessee in carrying on of his vocation and was as such taxable in his bands.
3. The differential price has resulted in benefits to the appellant-companies. According to Oxford Dictionary, benefit includes favourable or helpful factor or circumstances or gain or any advantage. According to Strounds' Judicial Dictionary, benefit is something much more than advancement. Within the above meaning the advantage availed by the appellant companies was in the nature of benefits. The benefit in this case is analogous to the perquisites mentioned in Section 17(2)(iii) of the Income-tax Act as explained in CBDT Circular No. 710, dated 24-7-1995. Appellant companies cannot compare the impugned preferential allotment of shares to rights issue. In a rights issue all the shareholders are given the option to subscribe to such issue. In the present case, the option was made available only to promoters group. The appellant companies would be getting higher dividends while holding the shares and would be earning higher profits while disposing the shares without commensurate investments when compared to others.
4. In all the returns filed by the appellant-companies for the earlier years, the income of dividend and interest were declared under the head 'Profits and gains of business or profession'. They have been consistently showing NIL 'income from other sources'.
Against the Dividends and interest income credited in the Profit and' Loss Account, the appellant companies have been debiting all their expenses of business. The loss determined in the assessments has been claimed for the benefit of carry forward and set off.
Auditors Report dated 23-12-1994 in para 3 sub-para (ix) observes that the companies have been dealing in shares. In the letter dated 6-10-1997, it has been stated that the principal business of the assessee-company is to deal in shares and securities of listed companies mainly in the nature of investment activity. Therefore, the contention by the appellant-companies that their only income is from 'other sources' and not from 'business' is clearly unfounded.
5. The main objects of the appellant-companies as set out in their Memorandum of Association are to carry on the business of investment, to acquire stocks and shares and to deal in them. The main activities carried on are doing investments in group companies as promoters. In all the returns filed so far, the business has been declared as investment in companies. This is supported by the Auditors' Report from time to time. In their order, the A.P. High Court has observed while approving the scheme of amalgamation in C.P. No. 01/95, that the appellant-companies were engaged in the business of investment in securities and shares and finances. In his statement made on 6-3-1998, Dr. K. Anji Reddy, the Chairman of the companies has, stated that these companies are the vehicles of investment of himself and his family members and are part of promoters group and the shares were preferentially allotted to prevent any possible hostile take-over of Dr. Reddy's Laboratories Ltd. In the light of the above facts and evidences, it is to be held that the appellant-companies were doing the business in shares of group companies.
6. There is a clear nexus between the benefits derived by the appellant-companies and the business carried on by them. The appellant-companies were engaged in the activities of promoting Dr.
Reddy's Laboratories Companies. The preferential allotment was made in appreciation of the services rendered by the appellant-companies in this regard. This is clear from the Minutes of the Extraordinary General Meeting of Dr. Reddy's Laboratories (P.) Ltd. held on 16-3-1994. It is recorded therein that the promoters should be allowed to take preferential offer of shares for the contribution made by them in the field of drugs. It is clear therefore, that the shares were allotted in appreciation of the services rendered by them. Rendering of services is a business activity and the nature of services may be varied. Reliance placed on-Lakshminarayan Ram Gopal & Sort Ltd. v. Government of Hyderabad [1954] 25 ITR 449 (SC) 7. The Assessing Officer held on the above grounds that the appellant-companies have derived benefits in acquiring the shares through the preferential allotment and the benefit has been arisen out of business carried on by them. Accordingly, the Assessing Officer confirmed her proposition and added Rs. 32,85,00,000 to the income of M/s. KNP Investments (P.) Ltd. and Rs. 29,70,73,500 to the income of M/s. KAR Investments (P.) Ltd. 12. When the assessments were challenged in first appeals before the CIT(Appeals), the appellant-companies urged the following further grounds of objections in addition to the grounds already raised at the time of assessments- 1. The appellant companies were not in existence at the time of assessments as they ceased to exist with effect from 1-10-1994, when they merged into Dr. Reddy's Holdings Ltd. as a result of amalgamation. Therefore, the impugned assessments are void ab initio and liable to be quashed. Reliance placed on CITv. Express Newspapers Ltd [1960] 40 ITR 38 (Mad.).
13. The learned CIT(Appeals) examined this ground in detail and held that the assessments are valid in view of the provisions contained in Section 292B, read with Section 170(2) of the Income-tax Act, 1961.
14. On the other grounds, invariably raised before the Assessing Officer also, the learned CIT(Appeals) made the following findings- 1. As per the Memorandum and Articles of Association, the main objects of the appellant-companies were (a) to carry on the business of investment; (b) to assist or aid in promoting companies; and (c) to buy and sell moveable assets of all kinds.
2. In the merger petition filed before the Hon'ble High Court, the appellant companies have stated to have carried on business of investment in securities and shares and finances.
3. The appellant companies have been consistently filing their returns of income declaring income under the head 'Profits and gains of business or profession' and they raised the objections that they were not carrying on business only when it was proposed under Section 28(iv).
4. The appellant companies have helped in promoting Dr. Reddy's Laboratories Ltd. and other group-companies by way of substantial subscription to promoters' equity, pledging its shares to banks for the benefit of Dr. Reddy's Laboratories Ltd. 5. The assessee-companies have invested in the shares on borrowed funds and the return from such investments being negligible, the investments have to be held as made for earning profit at the time of sale at a later date.
6. The contention of the appellant-companies that the shares were acquired for controlling interest in Dr. Reddy's Laboratories Ltd. was not proper as even after the preferential allotment of shares, the promoters group including the appellant-companies did not hold more than 50% of the issued shares of Dr. Reddy's Laboratories Ltd. 7. The appellant-companies entered into agreement with Margadarshi Financiers for forward sale of substantial shares of Dr. Reddy's Laboratories Ltd., immediately after the preferential allotment.
8. Taking into account the totality of the facts of the case and in view of the legal position as pronounced by the Supreme Court in CITv. Distributors (Baroda) (P.) Ltd. [1972] 83 ITR 377 and Madras High Court in CITv. Amalgamations (P.) Ltd [1977] 108 ITR 895. the appellant-companies did carry on the business of 'holding of investment'.
9. Since the benefit has arisen to the appellant-companies from its business of 'holding of investment', it is rightly taxed under Section 28(iv) of the Income-tax Act, 1961.
15. On the basis of the above findings, the learned CIT(Appeals) confirmed the respective additions made under Section 28(iv) and dismissed the appeals filed by the appellant-companies.
16. Now in these appeals, the appellant-companies have raised five sets of grounds before us. The first ground relates to the legal objection that the Assessing Officer has gone wrong in completing the impugned assessments in the names of the appellant-companies, who are non-existing and therefore, the assessments are void ab initio and bad in law. The third ground relates to the contention that the CIT(Appeals) has erred in confirming the assessment treating the benefit as taxable in the impugned assessment year 1995-96 instead of the assessment year 1994-95. Any how, at the time of hearing, Shri S.E.Dastur, the learned Senior Counsel, informed the Court that these two grounds are not pressed any more. In the circumstances, ground Nos. 1 and 3 relating to the legal objection and the assessment year respectively are dismissed as not pressed.
17. The remaining effective grounds to be considered in these appeals are concerning- (i) The real issue of applicability of Section 28(iv) of the Income-tax Act, 1961; These issues are contained in Ground Nos. II, IV and V respectively stated in the grounds of appeals filed before us.
1. The CIT(Appeals) erred in confirming the action of the Asstt.
Commissioner of Income-tax, Company Circle 4(5), Hyderabad ('the ACIT') by holding that the benefit has arisen to the appellant on the preferential and concessional allotment of shares of Dr. Reddy's Laboratories Ltd. "TRL" in terms of Section 28(iv) of the Act.
2. He further erred in making various immaterial, irrelevant and/or incorrect observations and conclusions which were contrary to and in total disregard of the actual facts and/or on misconstrued facts and were based purely on inferences, surmises, conjectures and including in particular that the appellant company did indulge in real substantial organised course of activity with the set purpose of earning profit and in view of that it was carrying on the business of holding of investments.
(a) The appellant company was investment company and was holding shares of group companies including shares of DRL and as such had derived income from investment in shares and securities; (b) the preferential allotment of shares in Dr. Reddy's Laboratories Ltd. ("DRL") so made to the Appellant and the shares obtained pursuant thereto were not for any other purpose but was to enhance and consolidate the managing group's control; (c) the mere fact that a loan had been raised with the help of a part of the total holding did not in any way suggest an intention to dabble in profit making activities through dealing; (d) the fact of a loan being obtained by an investor would be wholly irrelevant in judging whether the assessee was holding the shares as investment or stock-in-trade; (e) a switch of investments to enhance management control did not necessarily spell that there existed an adventure in nature of trade or was carrying on business; (f) there was no material to establish the only motive of the appellant in purchasing the equity shares in DRL was to sell them at profit; (g) even if one assumes that the sale was with a view to make profit that alone could not be the criteria for deciding that there was a business intention; (h) it is a settled law that the profit motive in entering into a transaction would not be decisive for determination of the issue and an accretion to capital could not be taxed as 'business income'; (i) the finding given by the Supreme Court in Distributors (Baroda) (P.) Ltd.'s case 83 ITR 377 was with reference to expression business of 'holding of investments' specifically used in Section 23A of Indian Income-lax Act, 1922 and confers companies whose primary or principal source of income is house property or capital gains as well; (j) mere fact that the company was incorporated to carry on business of investments did not show that it was carrying on business; (k) the mere holding of shares as investment could not amount to business within the meaning of the term business used in the Income-tax Act; (l) the Appellant was not the promoter of DRL and they had never rendered any services in connection with the formation or promotion of the company and that it had never aided in promoting DRL; (m) the onus to prove that the transaction was an adventure in trade or business was on the department and that the ACIT had failed to prove the same; (n) it is a settled law that the Memorandum is not conclusive proof for or against the activity carried by the assessee; (o) the issue of the said equity shares in DRL on preferential basis to the Appellant was on capital account and not on revenue account; (p) there was no benefit or perquisite arising on account of issue of preferential equity shares in DRL; (q) the Appellant had no right, much less vested right, to receive the equity shares from DRL at concessional price and as such no perquisite or benefit can be said to have arisen; (r) there was no nexus between the business of the Appellant, if at all any, and the benefit which the Appellant had derived, if at all any; (s) the question of the applicability of provisions of Section 28(iv) did not arise inasmuch as the value of benefit or perquisite was not arising from business; and (I) on the facts and circumstances of the case, the said addition was unjustified and unwarranted.
4. The Appellant prays that it be held that the difference of the price of allotment of shares in DRL, at preferential rate and prices of shares quoted on stock exchange on the date of allotment of the shares could not be brought to tax under Section 28(iv) of the Act.' 1. The ClT (Appeals) erred in confirming the action of the ACIT in considering the market value of shares in DRL at Rs. 455 per shares as quoted on Stock Exchange on May 6, 1994.
(a) the said shares allotted on preferential basis were subject to lock in period of 3 years as per the guidelines issued by SEBI and as such were not transferable for three years and that the same could not be treated on par with those that were regularly traded in Stock Exchange; and (b) the lock-in-period and the vagaries of share market should undoubtedly have to be borne in mind in determining the quantum of benefit.
3. The Appellant prays that the fair value of shares in DRL be taken at break-up value method for the purpose of computing the value of benefit.
4. Without prejudice, the Appellant prays that the market value of the shares in DRL after expiry of lock in period of 3 years be taken for the purpose of computing the value of benefit." 1. The CIT (Appeals) erred in not considering the ground relating to chargeability of interest of Rs. 10,88,10,331 under Section 234B and Rs. 4,649 under Section 234C of the Act.
2. He failed to appreciate and ought to have held that in the facts and circumstances of the case there can be no levy of interest under sections 234B and 234C of the Act.
3. The Appellant prays that the levy of interest of Rs. 10,88,10,331 under Section 234B and Rs. 4,649 under Section 234C be deleted." 21. Let us first examine the ground whether Section 28(iv) of the Income-tax Act, 1961 is applicable in these cases or not. Shri S.E.Dastur, the learned Senior Counsel appearing for the companies dealt with the issue in an extensive manner. He explained the legal situation that the appellant-companies would be caught in the web of Section 28(iv) only if all the following circumstances are satisfied with reference to the appellant-companies and their acquisition of shares through preferential allotment. While explaining the circumstances, the learned Senior Counsel first took us to the provisions of Section 28 of the Act with special reference to clauses (i) and (iv) thereof. They read as follows :.
"28. The following income shall be chargeable to income-tax under the head 'profits and gains of business or profession'- (i) the profits and gains of any business or profession which was carried on by the assessee at any time during the previous year; (iv) the value of any benefit or perquisite, whether convertible into money or not, arising from business or the exercise of a profession....." 22. The learned Senior Counsel stated that in the Scheme of the above provisions, clause (iv) would be applicable only in the preface of clause (i) above. Therefore, according to him, the said circumstances are as follows : 1. That the appellant-companies should have carried on any business at any time during the previous year; 3. That the benefit must be one arising from the business carried on by the appellant-companies; 4. That the benefit, if any, must be revenue in character; must be of income in nature; 5. That the benefit has arisen to the appellant-companies in a business transaction they had with Dr. Reddy Laboratories Ltd. (DRL).
23. He contended that none of the above circumstances have been satisfied in the case of the appellant-company. M/s. KNB Investments (P.) Ltd. and M/s. KAR Investments (P.) Ltd.; and absolutely there is no justification to hold that the appellant-companies have enjoyed any benefit taxable under Section 28(iv). M/s. DRL was contemplating an Euro-Issue of shares. In that context. Dr. Reddy Laboratories Ltd. was quite anxious to retain the control of its promoters even after the Euro-issue. In fact, the promoters meant Dr. K. Anji Reddy, the Chairman of the group companies; Shri M.P. Chary and their family members and close associates. The appellant-companies, M/s. KNB Investments (P.) Ltd. and M/s. KAR Investments (P.) Ltd. have already been holding shares in Dr. Reddy's Laboratories and other group companies in the context of group control exercised by these closely held persons. When such a contingency arose, so as to retain the group control. Dr. Reddy's Laboratories Ltd. had to issue shares by way of preferential allotment. Group control could be retained only if they could block the passing of a special resolution in a meeting for which the share-holding should not be less than 2596. This is because a special Resolution needs a 3/4th majority. When the Euro-issue was contemplated, the promoters have enjoyed a share-holding of more than 27%. It was in order to retain at least that level of share-holding, a preferential allotment of 22,50,000 shares was made. As a result of that preferential allotment, the group enjoyed almost the same level of share-holding even after the Euro-issue. But for the preferential allotment, this would not have been possible. As the only intent and purpose of preferential allotment was to retain the group control in the share-holding of Dr. Reddy's Laboratories Ltd., the allotments were made to the appellant-companies, M/s. KNB Investments (P.) Ltd. and M/s. KAR Investments (P.) Ltd. It could not have been allotted to the public at large through market as argued by the Revenue, as that would defeat the very purpose of preferential issue itself. The appellant-company, also had no intention to procure the shares of Dr.
Reddy's Laboratories Ltd. from the market. Therefore, the preferential allotment of shares does not partake the character of a business transaction. As the event was not a business transaction, the provisions of Section 28(iv) would not apply. The appellant-companies have not been carrying on any business. They were only holding the shares of group companies. They had not dealt in the purchase and sale of shares and securities. The entire income of the appellant-companies during the previous year comprised only of dividends and interest. They have not invested in the shares of any outside companies; nor did they deal in the shares of these companies. The appellant-companies have not indulged in any systematic or organised activities in any line of business, including investment. Their expenditure related to certain bare minimum establishment expenses only. In the circumstances, it could not be held that the appellant-companies have been carrying on any business during the relevant previous year. While referring to the Memorandum of Association of the appellant-companies, the statements and affidavits filed before the Hon'ble A.P. High Court in the context of amalgamation proceedings, filing of returns for earlier assessment years disclosing income under Business head etc., the lower authorities were only mentioning to peripheral and irrelevant issues and they are not decisive in looking into the real question whether the appellant-companies have carried on any business during the previous year. The Memorandum of Association of a company may include a number of object clauses. Generally, they are enabling clauses by which a company can carry on its activities in any of those areas covered by those clauses. But those enabling clauses are not invariably the test to decide the exact nature of activities carried on by a company. The nature of the activity has to be considered in the light of the facts and circumstances relating to each transaction. M/s. Dr. Reddy's Laboratories Ltd. and the appellant-companies had no business connection or any business activities with each other. The appellant-companies are only holding shares of group companies. They are not dealing in shares and securities. They do not have the infrastructure to do such business. The preferential issue of shares has been made only with the intention of retaining the group control in Dr. Reddy's Laboratories Ltd. even after the Euro-issue. In the circumstances, it could not be held that the appellant-companies have been doing investment business or for that matter, that the appellant-companies have been doing the business of 'holding of investment. The appellant-companies have only been holding shares of group companies and they have not been holding any investments in other companies.
24. Having argued that the appellant-companies have not been doing any kind of business and the preferential allotment of shares in M/s. Dr.
Reddy's Laboratories Ltd. was not a transaction in the nature of business, the learned Senior Counsel further argued that no benefit has arisen to the appellant-companies by way of preferential allotment of shares. The shares allotted to appellant-companies could not be sold for a lock-in period of three years. That was a mandatory condition of preferential issue. The share issue has been made observing all the provisions of the Companies Act, 1956 and the SEBI Regulations. It has been done in accordance with all the existing laws and regulations. The preferential allotment of shares was not a manipulative scheme. There was no secret agenda. Everything was transparent. The allotted shares were not quoted in the stock exchange. It cannot be sold for three years. As such, it is very absurd to presume that the shares arc comparable to the market value of shares quoted in the stock exchange.
The so-called benefit presumed by the Department could be crystallised only if the shares could be sold on the date of allotment. If those shares could not be sold in the market, there is no market value for those shares issued through preferential allotment. Therefore, there is no meaning in comparing the issue price of Rs. 90 per share to the market price of Rs. 455 per quoted share. As such a comparison is unfounded. Accordingly, no benefit has arisen by virtue of preferential allotment of shares. If at all benefit has to be derived, the shares have to be sold. That could be made only after three years. One does not know what would be the market price after three years from the date of preferential allotment. The quoted price of Dr. Reddy's Laboratories during the 23 months ending May, 1994 had fluctuated between a high price of Rs. 560 per share to a low price of Rs. 62.50 per share. The average price was Rs. 248 per annum. Therefore, it is very unsafe to hold that the sale of those shares would fetch a profit compared to the issue price. The price may even come down. As the situation was uncertain regarding the sale price at the time of sale, no benefit could be considered on the basis of the difference between the market price and the issue price on the date of allotment. If at all there could be a profit on sale of shares allotted on preference, that profit would arise only at a future date after three years on the expiry of the lock-in-period. Therefore, at the maximum, the concept of benefit could only be prospective. A prospective or potential benefit could not be considered as income of the previous year in terms of Section 28(j'v) of the Income-tax Act.
25. The learned Senior Counsel further argued that the benefit contemplated in Section 28(iv) is a real benefit in the character of a positive income. It cannot be negative or unreal. While alloting shares at Rs. 90 per share as against the prevailing market price of Rs. 455 per share, what in fact the appellant-companies could have was only a saving in the cost of acquisition of shares. A price-saver or a reduction in the purchase price cannot be construed as benefit in the nature of income. He invited our attention to a relevant CBDT Circular explaining the intent and purpose of clause (iv) of Section 28, according to which the benefit should be a tangible one in consideration of a business transaction. The learned Senior Counsel submitted that the issue price of Rs. 90 per share was not determined arbitrarily. The issue price is supported by a contemporaneous valuation report prepared by M/s. C.C. Chokshi & Co., Mumbai. As the preferential issue of shares had no comparison with market price, the issue price was rightly fixed in comparison with the Valuation Report.
Therefore, there could not be any benefit for the appellant-companies in acquiring shares at Rs. 90 per share.
26. Without prejudice to contentions noted above, the learned Senior Counsel further submitted that if at all there was any benefit arising to the appellant-companies, that was not in the nature of income contemplated in Section 28 of the Income-tax Act as the benefit would be capital in nature and not revenue. He contended that the acquisition of shares was made for the purpose of Management Control and not for the purpose of any trading or business. Therefore, those shares are in the nature of capital and not stock-in-trade. Therefore, any benefit arising out of such capital asset would only be capital in nature.
Therefore, the same could not be a subject-matter of discussion under Section 28(iv) of the Income-tax Act, 1961.
27. He also submitted that cash payments are outside the purview of Section 28(iv) of the Income-tax Act. He contended that none of the circumstances necessary to invoke Section 28(iv) existed in the present case, and therefore, the whole exercise of the Assessing Officer was quite uncalled for. He stated that the mandatory circumstances did not exist because- 1. The appellant-com panics have not carried on any business, but only held selected shares; 2. They do not have any business relationship with Dr. Reddy's Laboratories Ltd. 3. The transaction of allotment of shares was not in the nature of business.
4. Therefore, the benefit if any could not be held to be arising out of business.
28. The learned Senior Counsel finally consolidated his propositions in the following lines- 1. For there to be a benefit to be taxed under Section 28(iv), there must be 'business income' taxable under Section 28(1) in the first place. Where there is no business, there can be no taxation of a perquisite or benefit, as that must arise from the business carried on under Section 28(1).
2. The appellant-companies having neither sold the shares of Dr.
Reddy's Laboratories Ltd. [except one solitary transaction of sale by M/s. KAR Investments (P.) Ltd.] nor any other with a view to make profit by means of a systematic and organised activity of investment, it cannot be said to be in 'business of holding investments' as considered by the Supreme Court in Distributors (Baroda) (P.) Lid's case (supra) at page 383.
3. Admittedly, the appellant-companies have no infrastructure; have not carried out any business activity; and have no income from business, and the fact that in the earlier assessment years the appellant-companies have been assessed to business income, when in fact it had only income from dividends, is not a conclusive factor, and there cannot be any estoppel on this count. Reliance is placed on the following decisions- (c) Dy. CITv. Magarjuna Investment Trust Ltd. [1998] 65 ITD 17 (Hyd.) (SB) 4. The appellant-companies arc not the promoters of Dr. Reddy's Laboratories Ltd., and even as per the definitions extracted by the Assessing Officer the appellant-companies could not have promoted and formed the Dr. Reddy Laboratories Ltd., as the Dr. Reddy's Laboratories was promoted and formed prior to the incorporation of the appellant-companies.
5. The option sale agreement with Margadarsi was a loan transaction coupled with security and concluded as a loan transaction with interest at a rate 12.5%.
6. Facilitating the obtaining of a loan by Dr. Reddy's Laboratories Ltd. in the past by pledging shares of Dr. Reddy's Laboratories held by the appellant-companies was not a business transaction as no fee was charged.
7. Admittedly the shares even as per the Assessing Officer are capital assets al all points in time. Thus any 'benefit' if any could only be on capital account which would be taxed when the shares were transferred. The shares of Dr. Reddy's Laboratories Ltd were never purchased from the open market but acquired by way of subscription, rights, bonus etc.
8. Where assets are purchased with a view to obtaining control whether with borrowed funds or not, the profit from the sale of those assets would be on capital account and it would not amount to a business activity. Reliance is placed on the following decisions- 9. In the abovementioned cases, the Hon'ble Supreme Court has categorically stated that the fact that the objects in the Memorandum of Association provided for trading in shares or the fact that the appellant had borrowed to purchase the assets or shares was a factor which did not detract from the fact that the shares were on capital account.
10. In fact propositions above are also supported by the decision of the Hon'ble Supreme Court in Distributors (Baroda) (P.) Ltd.'s case (supra), the principle that the shares purchased with a view to obtaining a managing agency would not be stock-in-trade, namely business assets. There has been no systematic organised activity of investment with a view to making profit in order to make the activity carried on by the appellant as the business of holding investment.
11. Where in accordance with law and after compliance with the requisite legal formalities under SEBI or under the Companies Act/law shares are purchased at 'lesser price", Section 28(iv) cannot apply as it does not apply to cases where an assessee is able to purchase at a lesser price. It can only apply to cases where the assessee is able to secure a tangible benefit in consideration of a business transaction. This is made explicitly clear by the Circular of the Central Board of Direct Taxes, at the time of introduction of Section 28(iv).
12. As held by the Gujarat High Court in CIT v. Spunpipe & Construction Co. Ltd. [1965] 55 ITR 68, where assets are purchased for lesser price, there can be no profit made by the purchaser on revenue account from the purchase at a lesser price.
13. In any event and without prejudice to the above, the benefit or perquisite sought to be taxed must be one arising in the course of business carried on. In other words, it must be "in consideration of a business transaction between the two parties". This proposition is supported by the following decisions- (c) CIT v. General Electrodes & Equipments Ltd. [1985] 155 ITR 78 (Bom.) (e) CIT v. Balvantmi Vtihadas Shah [1994] l96 ITR 379(Guj.) - besides the relevant CBDT Circular.
14. The benefit if at all arises on capital account not from exercise of business cannot be assessed under Section 28(iv).
Reliance is placed in this behalf on the following decisions -Comfund Financial Services (I) Ltd. v. Dy, CIT [1998] 67 ITD 304 (Bang.) 15. The decision of the Hon'ble Rajasthan High Court cited by the learned Departmental Representative in CIT v. K.L. Kasliwal [1994] 207 ITR 208 is clearly distinguishable as in that case, the appellant had himself returned an amount of Rs. 4,000, under Section 28(iv). The only question was whether in view of the expenditure expended by the firm on renovation of the premises it would be enhanced to Rs. 9,000. It was primarily a case of valuation of the benefit. Also, it was a case where a tangible benefit was received by an assessee, and not a case where assets are purchased at a lesser price.
16. The issue of shares at a lesser price would have normally resulted in a liability to gift-tax in the hands of Dr. Reddy's Laboratories and just because the provisions of the Gift Tax Act was not applicable (see Section 45 of the Gift Tax Act) to Dr. Reddy's Laboratories Ltd., being a company the shares of which are quoted on the stock market cannot mean that a liability arises under Section 28(iv) of the Income-tax Act.
17. In any event in view of the value of the shares having been determined by M/s. C.C. Chokshi & Co., at Rs. 88 issue at Rs. 90 is fully supportable.
18. In view of the lock-in-period statutorily required of the said shares, the appellant companies did not have any benefit or perquisite accruing in the said assessment year. In any event, the value of the shares could only be taken without prejudice to the above at the market value prevailing on the expiry of the lock-in-period, viz, Rs. 217.
19. The wide fluctuations in the quoted price from time to time shows that where there is a lock-in-period one cannot assess a benefit on the basis of the then prevailing market price.
The facts specifically stated in the above prepositions mainly relate to the case of M/s. KNB Investments (P.) Ltd., but the facts are similar in the case of M/s. KAR Investments (P.) Ltd., except that there was no transfer of any share of diano Hotels and there as one solitary transaction of sale of Dr. Reddy's Laboratories shares. In the preceding previous year M/s. KAR Investments (P.) Ltd. had sold 4,000 shares of Dr. Reddy's Laboratories to Globe Organics (P.) Ltd. to extinguish the loan it had obtained from Globe Organics itself. The loan was taken by M/s KAR Investments in respect of a buy-back arrangement with IDBI and IFCI of shares held by them in Globe Organics. There was no business "as such", nor at any time prior or thereafter M/s. KAR Investments ever sold any of its holdings in Dr.
Reddy's Laboratories.
29. Shri C.P. Ramaswamy, the learned Senior Departmental Representative appearing for the Department contended that all the arguments made by the learned Senior Counsel appearing for the appellant-companies, are purposefully drifting away from the essential facts of the case and the laws relevant thereto. The learned Departmental Representative stated that the statutory documents of the appellant-companies like Memorandum of Association, etc., have clearly stated the nature of business carried on by the appellant-companies. The appellant-companies are doing business in investments, the investment by itself is a recognised business, and there is no point in saying that the appellant-companies were not carrying on any business at all. He also stated that the Assessing Officer has apprehended that even the minute books reflecting the proceedings in Annual General Meetings, where the business carried on and the business prospects might have been discussed by the members of the companies were fabricated to suit the convenience of the appellant-companies. The appellant-companies stated before the Hon'ble High Court of Andhra Pradesh through various petitions and affidavits and statements made in the context of amalgamation proceedings that the appellant-com panics have been carrying on business in investment. The appellant-companies have been filing their returns of income for all the assessment years under the head 'profits and gains of business or profession', and at no point of time, the appellant-companies had raised any contention that they were not carrying on business. The learned Departmental Representative submitted that the Assessing Officer has extensively dealt with this matter and has clearly established that the appellant-companies have been carrying on business as investment companies. The learned Departmental Representative also pointed out the benefit enjoyed by the appellant-companies, by availing the facility of preferential allotment of shares. He submitted that the shares of Dr. Reddy's Laboratories are quoted at Stock Exchange at Rs. 455 per share, whereas the appellant-companies got the same for Rs. 90 per share. The allotment was not made to the public at large, including its existing shareholders, other than the appellant-companies. The benefit of concessional rate or preferential allotment was not extended to all the shareholders, but it was extended only to selected members, viz., the two appellant-companies. By virtue of this discretion itself, it is quite apparent 'that the preferential allotment of shares was made with a specific intention of conferring benefits on the appellant-companies. The learned Senior Departmental Representative further pointed out that there is no point in distinguishing between the benefit so derived under Section 28(iv) as capital or revenue.
Since the benefit has arisen out of the business carried on by the assessee, and as such it is treated as benefit, there is no further need of examining the nature of that benefit, viz., capital or revenue.
Such characterisation is not contemplated under the provisions contained in Section 28(iv) of the Act. The learned Departmental Representative further submitted that by holding the shares of the selected companies and earning income by way of interest on those shares or by earning profit on the sale of those shares, the appellant-companies are at least doing the business of 'holding' the investments. This proposition has been correctly pointed out by the learned CIT(A) in the impugned order, relying on the decisions in Distributors (Baroda) (P.) Ltd. '5 case (supra) and Amalgamations (P.) Ltd. 's case (supra). The Hon'ble Supreme Court has recognised the principle that 'holding' of investments itself is a business. Once carrying on of the business is proved, the next question to be considered is whether there is a benefit. Without explaining those things in very many words, it is absolutely clear, the learned Departmental Representative argued, that the appellant companies have acquired the shares of Dr. Reddy's Laboratories at the rate of Rs. 90 per share, though the prevailing rate of the same in the market at the relevant time was Rs, 455 per share. Consequently, the differential price partakes the character of 'benefit' and comes under the purview of Section 28(iv) of the Act. The benefit, according to him, is certain and it is correctly valued. Therefore, the learned Departmental Representative submitted that the present cases coming under the circumstances explained by the learned senior counsel for the assessee, are clearly caught in the web of Section 28(iv) of the Income-tax Act, 1961. The appellant companies, according to him have derived benefit coming under Section 28(iv) of the Act. He submitted that the conditions necessary for attracting clause (iv) of Section 28 have been satisfied in these cases, in the following manner- (i) That the appellant-companies had carried on business of dealing in investments during the previous year; (ii) That the appellant-companies have derived benefit out of the transactions in question; (iii) That the benefits derived by the appellant-companies have arisen from the business carried on by them; (iv) That the benefits have arisen to the appellant-companies in the business transaction which the appellants had with M/s. Dr. Reddy's Laboratories Ltd. (v) That there is no legal compulsion to examine the question whether the benefit derived by the appellant-companies is of capital or revenue nature.
30. The learned Senior Departmental Representative has filed a synopsis of the Department's submissions. In support of its contention that the assessee carried on the business of holding of investments, it is stated therein that the assessee-companies had a systematic, organised, continuous activity of investing in the equity of group companies as evident from the Balance Sheets. Investments are made in a number of group companies on a regular basis, whenever group companies needed to raise funds. The appellant-companies have also admitted to have carried on business of investments in shares and securities through the Memorandum of Association; reports of the auditors; reports of official liquidators; returns of income filed for earlier years; and submissions made before the High Court of Andhra Pradesh in the amalgamation proceedings. Holding of investments is a business activity, as recognised by the Hon'ble Supreme Court in Distributors (Baroda) (P.) Ltd's case (supra). That principle was applied by the Madras High Court in Amalgamations (P.) Ltd. s case (supra). M/s. KAR Investments (P.) Ltd. had sold 4,000 shares of Dr. Reddy's Laboratories in financial year 1993-94 at Rs. 1255 per share, which is the market price prevailing at that time, to another group company. Both the appellants had entered into forward contracts with M/s. Margadarsi Financiers for the sale of the shares of Dr. Reddy's Laboratories held by them. So also, the appellants had pledged the shares with Canbank Mutual Fund and ANZ Grindlays Bank for obtaining loan for Dr. Reddy's Laboratories Ltd: They have also pledged the shares to the Lead Managers of the GDR issue of Dr. Reddy's Laboratories. It is also to be seen that the appellant-companies have fabricated their minute books in order to conceal the real activities carried on by them in the form of business.
Adverse inference has to be necessarily drawn on the basis of this situation.
2. On the aspect of benefit involved in the preferential allotment of shares in question, it is stated that there is clearly benefit to the appellant-companies in the preferential allotment of shares. The appellant-companies could obtain the shares of M/s. Dr. Reddy's Laboratories at Rs. 90 per share, though the market value of the same was Rs. 455 per share at the relevant time. It is to be seen that this opportunity was not available to any other person of the public and not even to the other existing shareholders of the Dr. Reddy's Laboratories. This benefit, it is stated is analogous to the benefit construed in Section 17(2)(iii) of the Income-tax Act, 1961. As per the CBDT Circular No. 710 dated 21-1-1995, where an employee is allotted shares in the company at less than the market value, the difference between the market value and issue price is assessable as benefit under that section. This has now been incorporated as Section 17(2)(iii) with effect from 1 -4-2000. The benefit under Section 28(iv) is analogous.
The lock-in period prescribed in the share issue in the present cases does not take away the benefit enjoyed by the appellants in these cases. There is thus, accretion to the net worth of the appellant-companies and such accretion has come at a cheaper rate compared to the cost of acquisition of shares at the market rates. The credit rating agencies generally treat such benefit as secret reserve.
3. On the aspect of the Department's contention that the benefit in question has arisen from a business transaction, it is pointed out that the purchase of the preferential shares was just one other investment transaction of the appellant-companies in the business of holding investments, and therefore, the benefit has directly arisen from the business transaction in the ordinary course. The words used in Section 28(iv) are 'arising from', which have wider import as opposed to the words 'derived from'. Reliance is placed in this behalf on the following decisions- 4. Reiterating its stand that the benefit involved in the present cases is clearly income under Section 2(24), it is stated that the question whether the benefit in question is of capital or revenue nature does not arise because of Section 2(24)(vd). It is stated further that it is not necessary for every assessee to have every type of income listed in Section 28.
5. It is argued that the sale of 4,000 shares by M/s KAR Investments (P.) Ltd. during the financial year 1993-94 at Rs. 1,255 and forward contract for sale of shares to M/s Margadarsi Financiers at Rs. 500 per share or average quotation of preceding 15 trading days, are clearly indicators to the assessee's own estimation of the value of the shares procured through the preferential allotment. Therefore, it is clear that the benefit arising to the appellant-companies could be clearly and precisely measured. Reliance is placed in this behalf on the following decisions- 6. The learned Departmental Representative has also submitted replies of the Department item-wise to the arguments raised by the learned counsel for the appellant-companies in a tabular form. He has also attempted in the said tabulation, to distinguish the various case-laws cited by the learned counsel for the assessee.
31. We heard both sides in detail. We considered the rival contentions and the relevant arguments advanced from both sides. We have also gone through the paper-books and brief synopsis filed for the appellant-companies and the Revenue. Regarding the paper-books filed before us, we have scanned through the relevant and necessary papers only and have not considered anything in the nature of fresh materials and/or additional evidence.
32. The appellant-companies have acquired the shares at Rs. 90 per share through the preferential allotment made by Dr. Reddy's Laboratories Ltd. The prevailing market price at that time was Rs. 455 per share. The differential price is Rs. 365 per share. Whether this price differential availed by the appellant-companies amounts to benefit arising from business or not, is the issue to be decided in these appeals.
33. The shares on the basis of preferential allotment were made over to the appellant-companies on 10-5-1994- The issue price was Rs. 90 per share; the face value of the share was Rs. 10; and the premium of Rs. 80 per share. An examination of certain contemporaneous facts relating to the share value of Dr. Reddy's Laboratories would be interesting at this stage. M/s. Dr. Reddy's Laboratories Ltd. had obtained a share valuation report, prepared by M/s. C.C. Chokshi & Co., Mumbai. The said Report dated 19-9-1994 was prepared on the basis of the State of affairs of M/s. Dr. Reddy's Laboratories as on 31-3-1994. The valuation report was obtained in the context of the amalgamation scheme of M/s.
Standard Equity Fund Ltd. and Dr. Reddy's Laboratories Ltd. with effect from 1 -4-1994. The report is available from pages 60 to 101 of appellants' paper-book Vol. I. The shares have been valued on break-up method. Profitability also has been taken into consideration linking between historical profits and estimated future maintainable profit (Para 14.5 of the Report--page-77 of paper-book). On that basis, the shares of Dr. Reddy's Laboratories Ltd. have been valued at Rs. 90 per share as on 31-3-1994 (Page 69 of paper-book--Annexure C of the Report--Paras 11.3 and 11.4 of the Report). The above value of Rs. 90 per share has been worked out before considering the Bonus issue, preferential issue and Euro Issue of shares made by M/s. Dr. Reddy's Laboratories Ltd. after 31 -3-1994. When those issues were also taken into consideration, the share value has come down to Rs, 88 per share.
In the said Valuation Report, the consultants have considered the price fluctuations of the shares of M/s. Dr. Reddy's Laboratories Ltd. in the stock market, for a period of 23 months ending May, 1994 (Para 16.7 of the Report Page 83 of paper-book Vol. I). The market price has fluctuated from the highest price of Rs. 560 per share in April 1994 to the lowest price of Rs. 62.50 per share in the third quarter of 1992.
The summary of the market values of Dr. Reddy's Laboratories Ltd. shares is given in Annexure 1 to the Valuation Report (Page 101 of Paper-book Vol. I).
34. On an examination of the contemporaneous facts considered in the above paragraph, it is clear that the issue price of Rs. 90 per share is comparable to the break-up value of shares. In such circumstances, when the market price is not considered, where the net worth value alone is considered, the ultimate reward for the appellant-companies is an eventual capital gain, supplemented by a dividend yield. The reward of capital gains arises only when the appellant-companies ultimately sell the shares of Dr. Reddy's Laboratories Ltd. for a higher price than paid for the acquisition. The supplementary reward of dividend yield as such does not bestow any benefit upon the appellant-companies.
This is because the dividend is declared on the basis of the face value of shares which is the same for all the shareholders, irrespective of the price paid by them for the acquisition of shares. This is the position when the issue price of Dr. Reddy's Laboratories Ltd. shares is compared with that of Net worth Price/Value.
35. Now coming to the case argued by the revenue, the 'benefit' is contemplated in the differential price of Rs. 365 per share on a comparison of issue price of Rs. 90 per share with the market price of Rs. 455 per share. There is no such 'benefit' where the comparison is between the issue price and the net worth value. The case of 'benefit' is attempted on a comparison of the issue price and market price. The contemplated benefit is a price saver in a context when the issue price is compared to the then prevailing market rate. Or the contemplated benefit is relative in nature; relative to the prevailing market price.
Even in circumstances where the issue price is compared to the market price, there need not be such a relative benefit in all cases. In paragraph 33 above, we have seen the market price fluctuation in the case of Dr. Reddy's Laboratories Ltd. shares. The share value was Rs. 62.50 per share in the market in the third quarter of 1992. If the present issue price of Rs. 90 per share is compared to the then prevailing market price of Rs. 62.50 per share, it is obvious that there could be no benefit or advantage. Therefore, the advantage or benefit on the basis of a comparative price saver is subject to the market price prevailing on a particular day.
36. Where the benefit is related to the prevailing market price, the issue to be considered is whether there is any sustainable basis for a comparison of issue price with the market price. One of the objects of preferential allotment of shares was to retain the control of Dr. K.Anji Reddy and his associates in the ownership and management of M/s.
Dr. Reddy's Laboratories Ltd., even after the Euro-issue of shares.
This objective was made clear in the Explanatory statement circulated by M/s. Dr. Reddy's Laboratories Ltd. among its shareholders, pursuant to Section 173(2) of the Companies Act, 1956. The Explanatory statement was a legal requirement to accompany the notice of the Extraordinary General Meeting, where special resolutions were proposed to be considered and passed. The relevant explanation in respect of the preferential allotment of 22,50,000 equity shares given as item No. 4 of the said statement reads as follows- "In the light of the proposed Euro-issue and to guard against any take over bid by any other company, Indian or foreign that may arise out of the globalisation of Indian Economy which is possible in the international corporate scenario particularly in the Drug industry, it is felt desirable by the Board of Directors that in the interest of the Company, the promoter group's slake in the equity of the Company should be strengthened to enable them to have effective control of the management of the company and to offer additional equity shares at an affordable price to them." It is with the above objective that the Special Resolution was passed on the basis of which the preferential allotment of shares was made to the appellant-companies. The shares were allotted observing the relevant provisions of law contained in the Companies Act, 1956, Rules and Regulations formulated by SEBI and the Stock Exchange. The statement showing the percentage of holding by Dr. K. Anji Reddy and associates in Dr. Reddy's Laboratories Ltd. before and after the Euro-issue is given in page 19 of the supplementary paper-book. The percentage of holding before the Euro-issue and before preferential allotment was 27.68%. The percentage of holding after the Euro-issue and preferential allotment was 27.31%. This position is almost comparable. If there was no preferential allotment of shares, then the percentage of holding after the Euro-issue would have been 22.77%. It is clear that the promoters' group was holding a percentage of more than 25 in the equity of Dr. Reddy's Laboratories Ltd., and they could retain or maintain the same level of holding only because of the preferential issue of shares. If there was no such preferential allotment, the group's holding would have come down to less than 25%, to be precise at 22.77%. As pointed out by the learned CIT(A), the promoters' group never had a 51% shareholding in Dr. Reddy's Laboratories Ltd. so as to claim a majority and to stall any possible take over bid. But, as rightly argued by Shri S.E. Dastur, the learned Senior Counsel for the appellants, the minimum holding of at least 25% always helped the promoters' group to block the passing of any special resolution proposed by any hostile group at any point of time, as passing of Special Resolution needed a minimum of 75% of voting power.
It means, the promoters could retain their control over the management of the company even after the Euro-issue. There should not be a misconception regarding the majority shareholding and the effective group control in the management of Dr. Reddy's Laboratories Ltd. An absolute majority in the shareholding having more than 50% of voting power is of course the ideal situation for the promoters' group in any company. But in real life of corporate affairs, one hardly comes across such an ideal and academic situation. Where there is no majority shareholding, the next best alternative is to retain controlling interest by holding at least 25% of the equity, so that effective control can be held in the day to day affairs and policy management of the company. The stains quo could be maintained by avoiding basic changes in the dynamics of the company structure. In this perspective, the preferential issue of shares by Dr. Reddy's Laboratories Ltd. cannot be considered independent of the object of the issue discussed above. A clear nexus is established between the object of retaining controlling interest and the preferential issue of shares.
37. When the shares were acquired by the appellant-companies with the specific objective of retaining the controlling interest in Dr. Reddy's Laboratories Ltd., there cannot be a presumption that those shares were acquired for resale in the stock market and earn profit out of that. If a person acquires a large block of shares with the object of the acquisition of the controlling interest of the company whose shares are to be purchased, the inference is inevitable that the intention was not to acquire them as part of the person's stock-in-trade. Subsequent disposal of some of the shares so acquired does not make the transaction an adventure in the nature of trade. This was the view of the Hon'ble Supreme Court in the case of Ramnarain Sons (P.) Ltd. (supra).
Where sale of those shares was not contemplated, there is no justification in comparing the market price of existing Dr. Reddy's Laboratories shares with the preferential issue price of shares. One of the strongest arguments of the Revenue is that the appellant companies have derived the benefit through the preferential issue of shares of Dr. Reddy's Laboratories Ltd., as the issue was not made available to the public at large. The main objective of preferential issue was to maintain the group control, even after the Euro-issue. That is why the shares were allotted to the promoters and their core associates. If shares were also offered to the public at large as argued by the revenue, the very purpose of the preferential issue would be defeated.
38. As the preferential issue was made with a specific purpose, there was no contemplation of any immediate sale of shares. This is the factual aspect. Legally also, the appellant-companies could not sell those shares before the expiry of a lock-in-period of three years. One of the mandatory conditions of preferential issue of shares was a compulsory lock-in period of three years, and as a matter of fact, that lot of shares allotted through preferential issue was not quoted in the stock-market, as it could not be.
39. As seen in the above paragraphs, one of the main objects of preferential issue of shares was to retain the group control in Dr.
Reddy's Laboratories Ltd. Therefore, Dr. Reddy's Laboratories Ltd. could not have offered the shares to public at large. That would defeat the purpose itself. The shares cannot be quoted in the market because of the compulsory lock-in-period of three years. Therefore, those shares were not quoted in the market. In the circumstances, those shares that could not be quoted in the market, cannot be a subject matter of comparison with the existing shares already quoted and traded in the stock market. There is no basis or justification in making a comparison between unequals. Such a comparison is hypothetical.
40. The appellant-companies had no plan to procure shares from the stock market. Therefore, the market price did not apply. It was a preferential allotment lawfully made. It was made for some strategical purpose of ownership and control. The new shares were locked up for a period of three years. It was not possible to sell the shares during the relevant previous year. The premises relied on by the revenue pre-suppose the arising of benefit in the nature of income on the principle of contemplated sale. The shares could be sold only after three years. The share value is highly susceptible to market fluctuations. We have already noted from the share valuation report that the shares of Dr. Reddy's Laboratories have fluctuated from Rs. 62.50 to Rs. 560 per share during the 23 month period ending May, 1994.
In the circumstances, one cannot safely predict what would be the market price of Dr. Reddy's Laboratories Ltd-'s shares after the expiry of three years. The market value depends on a lot of factors including general economic conditions, market buoyancy, the status of particular industry and the financial image of the particular company, etc. The appellant-companies would gain benefit on the sale of shares only if at that time the shares commanded a market price higher than the acquisition cost. To be simple, that part of the matter is uncertain.
The prospective benefit that might arise on the sale of shares in the future is uncertain.
41. The uncertain future benefit is the eventual capital gain that the appellant-companies may obtain on the sale of shares. Whether such a prospective income/gain could be construed as benefit taxable under section 28(iv) of the Income-tax Act, 1961? In Sir Kikabhai Premchandv.CIT [1953] 24 ITR 506, the Hon'ble Supreme Court has held that state has no power to tax any potential future advantage. The observation in the above case that regard must be had to the substance of transaction rather than to its mere form was later disapproved by the Hon'ble Apex Court in CIT v. B.M. Kharwar [1969] 72 ITR 603. But, the basic principle declared in Smt. Kikabhai Premchand's case (supra) that there could not be any levy of tax on a future income, still holds good. The Court of appeal in Mason (Inspector of Taxes) v. Innes [1968] 70 ITR 491 has pronounced the same basic, elementary principle of Income-tax Law that a man could not be taxed on profit that he might have, but had not made. If Mason's case (supra) was decided in this country, the decision would be the same as that of Court of Appeals, for the principle of leaving out of assessment any potential advantage, benefit or gain was firstly established by the Hon'ble Supreme Court in Smt.
Kikabhai Premchand's case (supra).
42. The above principle is in no way overlooked in the provisions contained in Section 28 of the Income-tax Act, 1961. For the purpose of our discussion, the relevant portion of Section 28 is quoted below : "28. The following income shall be chargeable to income-tax under the head "profits and gains of business or profession"- (iv) the value of any benefit or perquisite, whether convertible into money or not, arising from business or the exercise of a profession. ....." (Emphasis supplied) The statute has listed about six items of income chargeable to tax under Section 28. The opening words are "The following income shall be...". The words are not "The following items shall be...". The word 'income, is very important and purposeful. All the six different items should satisfy the character of 'income' so as to be taxed under Section 28. Those six items as such are not sufficient; every one of them should be in the nature of income. The income, obviously need to be real. Clause (iv), if edited for our purpose reads as follows : "The value of any benefit arising from business....". That is, the benefit must be one arismg from business during the relevant previous year.
While defining the scope of total income in Section 5 of the Act, the law has made a two-fold characterisation, viz. income accruing or arising. But while dealing with benefit in the nature of income in the context of Section 28, law has conspicuously omitted the concept of "accruing" and has prescribed only "arising". "Benefit arising" implies benefit arising in the previous year. In other words, the law has made the nature of benefit under Section 28(iv) very clear and precise. That is, the benefit must be income in character; and it should be arising in the relevant previous year. In the present case, the income is prospective on the condition of the future sale of shares. That income which is prospective in nature cannot be construed as "benefit arising" to the appellant- companies in the relevant previous year.
43. The basis of the argument that the appellant-companies have derived benefit in the preferential allotment of shares in the sense that the companies have not paid Rs. 455 per share, but paid only Rs. 90 per share, and thus the appellant-companies had a comparative price advantage, is again not well-founded. The Hon'ble High Court of Gujarat had an occasion to examine an issue on the similar line in Spunpipe & Construction Co. Ltd. 's case (supra). Justice P.M. Bhagwati, as then he was, speaking for the Bench held as follows :-- "Where a going concern including fixed assets and stock in trade is purchased, the difference between the book value of any part of the assets acquired by the assessee and the price paid by the assessee for the same cannot be regarded as revenue profit derived by the assessee. No profit at all is made by the assessee from the purchase of any of the assets. At the highest, what can be said is that assets worth a particular amount are purchased by the assessee for a smaller amount, but that does not represent the profit of the assessee." In view of the ratio laid down in the above judgment, it is very difficult to hold that the savings in the acquisition cost of shares on a comparative price advantage ts in the nature of benefit contemplated in Section 28(iv) of the Income-tax Act, 1961.
44. On the basis of our discussion of the issue in paras 33 to 45 above, we have come to the following findings- (i) That the alleged benefit is a 'comparative benefit'. It is an advantage, relative in nature. - Paras 33 to 35.
(ii) Thai there is no justification or sustainable basis for a comparison between issue price and market price. Such a comparison would only be hypothetical. - Paras 34 to 40.
(iii) That the benefit the appellant-companies might derive would be an eventual capital gain on the sale of shares after the lock-in-period of three years. That prospective benefit is again uncertain. Para 41.
(iv) That the benefit should be in the nature of income arising in the relevant previous year; it should be real income in the present and not a prospective income of future.--Paras 42 to 45.
(v) In fact the market price is applicable only to those shares quoted and traded in the market. It is not applicable to those shares that could not be quoted and traded in the market. For such shares, the correct method of valuation is break-up value method. In the present case, the break-up value and the preferential issue price at Rs. 90 per share are cross-matching. In between them, there is no price difference, and therefore, there is no benefit either.
45. In view of the above findings, we arc of the considered opinion that the benefit contemplated by the Assessing Officer on the basis of the comparative price differential between the preferential issue price and the market price of Dr. Reddy's Laboratories shares cannot be construed as "benefit", much less a "benefit in the nature of income" arising to the appellant-companies from business during the previous year relevant to the impugned assessment year 1995-96. As far as the relevant previous year is concerned, the benefit or advantage was only conceptual in nature as the real advantage or benefit would be in the nature of eventual capital gain to be derived on ihe sale of those preferentially allotted shares on a future date which would be beyond the close of the relevant previous year. Therefore, the additions made by the Assessing Officer in the assessments of the appellant-companies under Section 28(iv) of the Income-tax Act, 1961 are not sustainable in law. The addition of Rs. 32,85,00,000 made in the case of M/s KNB Investments (P.) Ltd. and the addition of Rs. 29,70,73,500 made in the case of M/s. KAR Investments (P.) Ltd. are accordingly deleted.
46. As we have decided these appeals on the primary issue of benefit itself, holding that there was no benefit arising to the appellant-companies in the preferential allotment of shares of Dr.
Reddy's Laboratories Ltd., it is found not necessary further to decide on the other circumstances necessary to attract the provisions of Section 28(iv) of the Income-tax Act, 1961. Therefore, the remaining grounds are not considered as it would be academic in nature.
47. In the result, appeals of the assessees are allowed, and the Assessing Officer is directed to modify the assessments.