Judgment:
1. The main issue arising in this appeal relates to disallowance of short-term capital loss of Rs. 25,88,784 incurred by it on account of renunciation of its right to apply for 115000 partly convertible debentures (in short PCDs) in favour of LIC Mutual Fund (in short LICMF) as well as on sale of non-convertible portion of 785 PCDs.
2. The brief facts of the case are that assessee-company held 231569 shares in Triveni Engineering Works Ltd. (in short TEWL). Vide its issue opened on 29th June, 1992, TEWL offered 15,75,000 14 per cent secured redeemable partly convertible debentures of Rs. 150 each for cash at par out of which 15,00,000 PCDs were offered on right basis to equity shareholders in the ratio of one debenture for every two shares held. Thus, the assessee was entitled to subscribe for 115785 PCDs. As per the terms of the offer, the assessee was entitled to subscribe for its entitlement wholly or in part. Alternatively, it could also renounce its right to apply, wholly or in part in favour of any other person. Each PCD had two parts. Part A comprised of convertible portion of Rs. 65, which would be compulsorily and automatically converted into a share of face value of Rs. 10 with a premium of Rs. 55 within 6 months of allotment of PCDs. Part B comprised of non-convertible portion being debenture of face value of Rs. 85 and carrying interest @ 14 per cent.
3. As per the terms of the offer, the assessee-company applied only for 785 PCDs and, as mentioned by AO, payment was made by cheque. The same were also allotted to assessee. The non-convertible debenture portion of 785 PCD was sold to M/s Credit Capital Financial Corporation Ltd., New Delhi @ Rs. 64.32 per PCD (Part B). Thus, it suffered a loss of Rs. 20.68 per PCD (Rs. 85 less Rs. 64.32) aggregating to Rs. 16,233.80.
However, for the balance entitlement of 115000 PCDs, the assessee under an arrangement renounced its right in favour of LICMF. Such arrangement was made through one Shri Dhru v M. Sawhney. The terms of such arrangement were contained in the letter dt. 13th June, 1992, written by Mr. Sawhney to assessee. The same are being reproduced as under: "(a) The equity shares arising on conversion of PCDs shall be bought back at an agreed price of Rs. 65 per share.
(b) The shares will be purchased within a period of three years from the date of subscription by LICMF. (c) Service charges @ 19 per cent p.a. would be payable on a quarterly basis to LICMF on the amount of outstanding shares. The above service charges would be reduced by the amount of interest and dividend, if any, received by LICMF from the Triveni Engineering Works Ltd. in the intervening period.
(d) In case of default made by the company, the service charges shall stand increased to 21 per cent p.a. compounded quarterly.
(e) LICMF will have the option to retain 7.5 per cent of the equity shares arising out of conversion of the PCDs.
(f) LICMF will also be entitled to 7.5 per cent of the bonus shares, if any, allotted by the Triveni Engineering Works Ltd. during the intervening period.
(g) LICMF will have the discretion to deal with any rights issue made by the Triveni Engineering Works Ltd. in the intervening period at their discretion.
(h) Part B of the PCDs of the value of Rs. 85 per PCD will be kept by LICMF. As a consideration of this, an upfront discount of Rs. 22.37 per Part B of PCD of Rs. 85 each would be payable to LICMF on non-convertible portion. The cheque/ draft for such upfront discount would have to be paid by the company at. the time of signing of the agreement with LICMF." The assessee accepted the above arrangement and authorized Mr. Sawhney to enter into a formal agreement with LICMF. As a result thereof, the formal agreement was made on 11th July, 1992, the copy of the same is placed at p. 34 of the paper book.
4. As a result of such arrangement, the assessee renounced its right to subscribe for 115000 PCDs in favour of LICMF who, out of its own funds, applied for such PCDs on 22nd July, 1992 and TEWL allotted the same to LICMF. In terms of the arrangement, the assessee had to pay the sum of Rs. 25,72,550 to LICMF (1,15,000 x 22.37) which was claimed as short-term capital loss. Thus, the total loss on this account was claimed as under: On renunciation of its right in 115000 PCDs Rs. 25,72,550 On sale of 785 PCDs Rs. 16,234 ______________ The above claim was accepted by AO under Section 143(l)(a) on 27th June, 1994. Later on, the assessment was reopened under Section 148 on the ground that assessee did not disclose, in the return, the details of the loss. In the course of reassessment proceedings, the assessee's contention before the AO was as under: "In terms of Rights offer made by M/s Triveni Engineering Works Ltd. the assessee-company became entitled to 115785 PCDs of Rs. 150 each.
This right to acquire the PCD is a capital asset and the profit or loss on the transfer of such a right is chargeable to income-tax under the head 'capital gains'. The assessee-company transferred its right to acquire the partly convertible debentures in favour of LICMF. In addition, the assessee-company was also required as per the agreement to give Rs. 22.37 per PCD to LICMF since LICMF required the PCDs to be purchased at less than the face value and had to be compensated in this respect. The transfer of such right to acquire PCDs was a transfer of capital asset and the amount paid by the assessee-company to LICMF was rightly treated as a capital loss being a part of cost of acquisition of such a right. In case such PCDs would have been renounced in favour of LICMF at a premium, then the resultant surplus would have been taxable as capital gains in the hands of the assessee-company. It may kindly be noted that the term capital asset means 'property of any kind held by an assessee'.
It is a settled legal position that the right to subscribe for shares/securities is a capital asset and surplus or loss arising on account of sale of such a right is chargeable under the head 'capital gains'. Reference may kindly be made to the decision in the case of Hari Bros. (P) Ltd. v. ITO (1964) 52 ITR 399 (Punj). It would, therefore, be evident that a right to purchase securities was acquired by the assessee-company. This right was transferred to LIGMF. The transfer was of a capital asset. The cost of Rs. 22.37 per PCD was incurred by the assessee-company which resulted in a loss on the transfer of such capital asset. The capital asset which changed ownership from the assessee-company to LICMF was a right to acquire the PCDs. Since the right to acquire securities was sold within two years itself without subscribing to the securities, obviously no amount would be added in the schedule for investment in the relevant year." However, the AO took the view that the assessee instead of transferring the right to purchase PCD has entered into an agreement with LICMF to avoid paying the full Rs. 150 per PCD and instead by paying Rs. 22.37 per PCD to LICMF has acquired the future right to purchase the Part A of the PCD from LICMF at a future date. Therefore, the payment of Rs. 22.37 is in the nature of an acquisition of a right to purchase shares of TEWL at a future date from LICMF. Therefore the amount is in the nature of capital expenditure to acquire a future right in shares and it cannot be said that there has been any capital loss to the assessee since LICMF has not paid any amount to the assessee to purchase any capital asset.
5. Further, it was opined by the AO that right to apply for PCD was a composite right in the sense that it was bound to purchase both the parts of the debenture at the cost of Rs. 150. That means that both the parts were inextricably linked to each other and it could not have purchased Part A or Part B separately. This composite right was transferred to LICMF with an option to buy-back Part A within three years. Part B was to be retained by LICMF. So, the transfer of such right was impliedly against acquisition of Part A at future date.
Hence, the consideration of Rs. 22.37 paid by assessee was towards acquiring of Part A of the debenture. Accordingly, it was held by him that such payment would form part of the cost of share which assessee would acquire at a future date.
6. It was also opined by him that there was no compulsion for assessee to transfer the right to subscribe. If it did not want to exercise that right, it could do so without incurring such loss. At the most, it was investment, for acquiring asset in future.
7. Accordingly, it was held by the AO that there was no transfer of any capital asset within the ambit of Section 45 of the Act. The claim of assessee amounting to Rs. 25,88,784 as short-term loss was, therefore, disallowed. However, it was further held by him that the sum of Rs. 22.37 per PCD paid by assessee would form part of cost of Part A of the debenture. Thus, the cost of share to assessee in future would be Rs. 87.37 (Rs. 65 + 22.37). In support of his aforesaid conclusions, he also relied on the decision of CIT(A) in the case of Xonix Enterprises in appeal No. 369/1996-97 for asst. yr. 1994-95.
8. Before CIT(A), same line of argument was repeated by the assessee, that right to subscribe to the PCD is a valuable right and is, therefore, a capital asset. Hence, the profit or loss on transfer of such right is chargeable to tax under the head 'Capital gain'.
Therefore, the amount paid to LICMF for renunciation of the rights to subscribe to PCDs was claimed as capital loss. It was further submitted before CIT(A) that, if there would have been profit on transfer of PCD or if they would have been renounced in favour of LICMF at a premium, then, the resultant surplus would have been taxable as capital gain in the appellant's hands. The appellant relied on Hon'ble Supreme Court's decision in Miss Dhun Dadabhoy Kapadia v. CIT (1967) 63 ITR 651 (SC) wherein it was held that loss on renunciation of right to subscribe new shares is a capital loss considering such rights to be a capital asset.
This decision was followed in CIT v. K.A. Patch (1971) 81 ITR 413 (Bom) and CIT v. Obewi Building & Investment (P) Ltd. (1993) 203 ITR 403 (Cal) The decision of the AO that assessee-company has paid @ 22.37 per PCD to LICMF for acquiring future right to purchase the Part A of PCD at a future date was assailed on the ground that LICMF has also a right to sell the shares of TEWL, obtained on conversion of Part A, in the open market in case of TITL does not buy-back these shares. Thus acquisition of shares by the appellant and the other group companies is a future event which may not take place depending upon the market condition. As such, the loss incurred by the appellant on renunciation of the right to subscribe to PCD cannot be linked to the acquisition of shares in future and thus loss incurred by assessee is not a part of price for acquisition of shares in future.
9. The CIT(A), however, did not agree with the appellant and held that the loss of Rs. 25,88,784 incurred by the assessee is neither allowable as a capital loss on the transfer of capital asset nor is the same allocable towards the cost of shares of TEWL which the assessee may acquire in the future. According to him, it is an expenditure incurred to ensure subscription of PCD of a group company, which is, therefore, an expenditure of a capital nature incurred for the benefit of the group company. The reason advanced by CIT{A) was that a capital asset cannot be transferred for a reverse consideration, i.e., the.
consideration here flow from the transferor to transferee and not from transferee to transferor. Secondly, a capital asset is by definition a property which has a value. If its value is reduced to zero, it ceases to be an asset and if assessee has to pay something for holding himself from it, then by definition it is a liability. The direction in which consideration flows from transferor to transferee is sole and sufficient determination of whether the subject-matter is asset or liability. The liability was to ensure that issue of group company is subscribed. The expenditure @ 22.37 per PCD was incurred in the course of bona fide management of the company, 10. The learned counsel for assessee, Mr. Vohra, has reiterated the stand of assessee taken before the lower authorities and, therefore, need not be repeated as the same has been stated in detail in earlier part of this order. He also drew my attention to the judgment of Hon'ble Bombay High Court in the case of CIT v. Tata Services Ltd (1980) 122 ITR 694 (Bom)'in support of the proposition that right to subscribe for PCD .is a capital asset within the definition of capital asset under Section 2(14) of the Act. He also relied on the judgment of Hon'ble Supreme Court in the case of Miss Dhun Kapadia (supra) for the proposition that loss on renunciation of such right is allowable as capital loss under Section 45 of the Act. It also relied on the Tribunal decision in the case of Nalwa Investment Ltd. which has been affirmed by the jurisdictional High Court [(2000) 245 ITR 538 (Del) (sic)]. He also drew my attention to the decision of the Tribunal in the case of Xonix Enterprises placed in the paper book at p. 53 to point out that the Order of the CIT{A), on which reliance was placed by AO, has also been reversed by the Tribunal. Further, reliance was placed on following Tribunal decisions:J.K. Corpn. Ltd v. Asstt. CIT (ITA No. 1099/Cal/1997, dt. 18th March, 1999).
2. Panchanan Investment Ltd (ITA No. 2590-91/Del/1999, dt. 12th June, 2003).
3. Mohair Investments & Trading Co. (ITA No. 112/Del/2000, dt. 30th Jan., 2004).Karam Chand Thapar & Bros. (Coal Sales) Ltd. v. Dy. CIT (2003) 78 TTJ (Cal) 825 : (2002) 83 ITD 171 (Cal) 11. On the other hand, the learned Departmental Representative has reiterated the reasonings of lower authorities and, therefore, need not be repeated.
12. Rival submissions of the parties have been considered carefully.
The question for consideration is whether the payment of Rs. 22.37 per debenture paid by assessee to LICMF at the time of renunciation of its right to subscribe for the debenture can be allowed as capital loss under the head 'capital gains'. In my humble opinion, the answer to this question is in negative for the reasons hereafter mentioned.
Section 45 of the Act is the charging Section which provides that any profits or gains arising from the transfer of a capital asset effected during the previous year is chargeable to tax under the head 'capital gains'. Section 48 prescribes the mode of computation of such profits or gains. According to this section, expenditure incurred in connection with the transfer as well as the cost of acquisition of the asset and the cost of improvement thereof has to be deducted from' the full value of the consideration received or accruing as a result of the transfer of the capital asset. The word 'transfer' in relation to capital asset has been defined in Section 2(47) of the Act. The combined reading of all these provisions shows that in Order to bring any profits or gains within the net of taxation under Section 45, then following conditions must be satisfied namely (i) there must be a capital asset; (ii) such capital asset is transferred during the previous year as per the definition clause 2(47) of the Act; and (iii) such transfer must be for consideration; (iv) there must be some cost of the asset. If the provisions of computation under Section 48 fail, then nothing would be chargeable to tax under the head capital gain as held by the Hon'ble Supreme Court in the case of CIT v. B.C. Srinivasa Setty (1981) 128 ITR 294 (SC).
13. Let me now examine whether such conditions are satisfied in the present case. There is no dispute to the contention of the assessee's counsel that right to subscribe the PCD is a valuable right and, therefore, falls within the definition of capital asset under Section 2(14) of the Act. Even the AO has accepted this legal position vide para 6 in his order. Further, it is also agreed that the act of renunciation of such right' would amount to 'transfer' within the meaning of Section 2(47) of the Act. However, in my opinion, the third condition remains to be satisfied in as much as in the present case, the assessee has not transferred the right against any consideration.
On the contrary, it is a converse case where the assessee has paid the sum of Rs. 22.37 per debenture to LICMF. The consideration in Section 48 means positive consideration received or accrued to the assessee from which cost of such asset and improvement thereof can be deducted.
It cannot include the converse situation. The loss would accrue to the-assessee if the consideration received is less than the cost of acquisition and cost of improvement under Section 48. Since no consideration was received by the assessee in the present case, the computation provisions fail and consequently, neither the profits nor the loss can be computed under the head 'capital gains' in view of the Supreme Court judgment in the case of B.C. Srinivasa Setty (supra).
Similarly, the right to subscribe the PCD accrued on account of its holding of shares in TEWL and not because of any consideration paid.
Hence, there was no cost of acquisition of such right. Therefore, on this account also, the computation provisions fail and the ratio of Supreme Court judgment in the case of B.C. Srinivasa Setty (supra) would squarely apply. If the consideration received by assessee on the transfer of asset could not be taxed under the head 'capital gain' in view of the ratio of above Supreme Court judgment where there was no cost of acquisition then for the same reasons, the loss also cannot be computed under Section 45 of the Act. Hence, the contention of assessee's counsel cannot be accepted.
14. Let me also examine this issue from another angle. As per the offer made by TEWL, there was no compulsion on the assessee to subscribe to such debentures. Accordingly, no prudent man would renounce such right with a view to incur loss by making payment to the transferee. If the payment is made to transferee, then one has to find out the intention of the parties as to why such payment was made. The entire scheme, under which the payment of Rs. 22.37 per debenture was made by assessee, has been looked into. The contents of' the letter written by Mr. Sawhney has already been reproduced in the earlier part of the order. The reading of the same shows that LICMF has actually charged service charges @ 19 per cent of investment made by LICMF for- Part A of the debenture o and the same was worked out to Rs. 22.37 per share after discounting. As per the terms of the agreement with LICMF, the assessee was entitled to buy-back the shares, allotted to LICMF on conversion of Part A of the debenture, within a period of three years.
Therefore, in my opinion, the payment of Rs. 22.37 per debenture was inextricably linked with the acquisition of shares at a future date, i.e., within a period of 3 years. Hence, the same would form the part of cost of acquisition of shares in future and by any logic cannot be considered as short-term capital loss. Hence, the finding of CIT(A) in this regard is incorrect and is vacated. In fact, the finding of AO that payment by assessee formed part of the shares to be purchased at future date was correct in this regard. In view of the above discussion, it cannot be said that payment of Rs. 22.37 related to renunciation of right to subscribe to the PCDs. Hence, the same could not be considered as short-term capital loss. Accordingly, the loss of Rs. 25,72,560 was rightly disallowed by the lower authorities.
15. At this stage, it may also be mentioned that there is distinction between loss on transfer of capital asset falling under Section 45 and loss of capital. The former is allowed as set off against the profits on sale of capital asset but the later is not allowed as deduction or set off against any income. For example, if any asset is transferred without consideration, it would be a loss of capital which cannot be set off against any income. In the present case, it is neither loss of capital nor loss on transfer of capital asset. It is a payment against the option to buy-back the shares at a future date and, therefore, would form cost of such shares when option is exercised. If, in any case, option is not exercised then it will be a case of loss of capital only.
16. On the other hand, we hold that loss of Rs. 16,234 on sale of non-convertible portion of the debenture was a loss on sale of capital asset in as much as all the conditions stand satisfied. The assessee had, in fact, acquired 785 PCDs out of its own funds and thereafter, sold the non-convertible portion. Thus, there was sale of capital asset against consideration. Further, assessee had also incurred expenditure on acquisition of such asset. Therefore, assessee was entitled to compute the capital loss under the head 'capital gains'. The Order of CIT(A), therefore, stands reversed on this aspect of the issue.
17. Before parting with this order, it would be appropriate to mention that various orders of the Tribunal, relied upon by learned counsel for assessee, are quite distinguishable in as much as : (i) in none of those cases, the assessee had renounced the right to subscribe the PCDs but on the contrary, in all those cases, the assessee had subscribed to the PCDs by making part payment out of their own funds at the time of application and it was only after the allotment of PCDs, the assessee had sold the non-convertible portion of the debenture (which is called khoka in the commercial world) in favour of financing institutions while in the present case what was renounced was only the right to subscribe to the PCDs and that too without consideration.
(ii) That in none of 'those cases, the assessee had made any payment at the time of renunciation of non-convertible portion of PCDs while in the present case, not only the right was renounced but the assessee also paid the sum of Rs. 22.37 per debenture to the financial institutions without consideration.
(iii) That in the case of Karam Chand Thapai & Bros, (supra), the non-convertible portion (NCD) was sold by the assessee for consideration of Rs. 235 per debenture against the value of Rs. 300 per debenture and thus there was complete transfer of that portion of the debenture against consideration while in the present case, assessee did not receive any consideration on renunciation of its right to subscribe and strangely on the contrary paid Rs. 22.37 per debenture to the transferee which no prudent person would do in the normal circumstances. Similar is the factual position in other cases relied on by assessee.
(iv) The judgment of Supreme Court in the case of Dhun Kapadia (supra) is also distinguishable on facts. In that case, the assessee renounced the right to subscribe against consideration while in the present case there was no consideration at all. Further, in that case, there was loss in respect of existing shareholding which was subject-matter before the apex Court while in the present case, loss related to renunciation of right to subscribe as contended by assessee. Hence, the ratio laid down by Supreme Court is inapplicable to the facts of the present case.
In view of the above discussions, it is held that the impugned transaction did not fall within the scope of Section 45 and, therefore, the loss could not be computed under Section 45 as short-term capital loss. On the other hand, it is held that payment of Rs. 22.37 per debenture was inextricably linked to the option to buy-back the shares from LICMF at future date and therefore, the same would form part of the cost of shares as and when the option is exercised by the assessee.
It is further held that loss of Rs. 16,434 on sale of non-convertible portion of 785 PCD will be allowed as short-term capital gain and the same shall be allowed to be set off in accordance with law.