Case: Accra Investments Private Limited Vs. The Income Tax Officer, Range-3(1)(1)

6) Brief facts leading to this appeal are asThe appellant assessee is a private limited company inter alia engaged in the business of investments having dividend, interest and capital gains as its sources of income 99.99% of the appellants share holding is held by one Mr. R. K. Jain.(b) For the assessment yearthe appellant assessee had declared long term capital gains at Rs.9,64,26,643/after indexation arising from sale of 30,70,000 shares in one M/s. Millennium Alcobev Private Limited (M/s. MABL) an unlisted company. The above shares were sold by the appellant to the other two shareholders of M/s. MABL i.e. M/s. Scottish & Newcastle (S&N) and United Breviaries Ltd.(UB). The appellant in its return of income claimed benefit of deduction of the entire capital gains as the same was invested in specified bonds under Section 54EC of the Act. The appellant had invested a sum of Rs.6,54,28,660/in M/s. MABL in the assessment year(May 2003) and sold it for Rs.16,66,60,000/during the assessment year(December 2005).(c) During the course of assessment proceedings, it was noticed that M/s. MABL is a private limited company engaged in the business of brewing and distribution of beer in India, Bhutan and Nepal. M/s. MABL was having manufacturing facilities spread over all over the country. On 16 May 2002 two agreements namely Subscription agreement and Shareholders Agreement were entered between S&N, UB and the appellant inter alia laying down the ground rules of their inter se relationship as the only shareholders of M/s. MABL. The above Shareholders agreement include the right of the appellant to be appointed Manager of M/s. MABL. Pursuant to the above agreements all the above three shareholders contributed by subscription to the share capital of M/s. MABL in May 2003 i. e. assessment yearThe contribution of S&N and UB was by subscribing to 40% of the issued equity share of M/s. MABL at share price of Rs.87.95 per share and Rs.35.83 per share respectively while the appellant subscribed to 20% of the issued equity shares of M/s. MABL at a price of Rs.21.30 per share.(d) The Assessing Officer by order dated 29 December 2009 held that the amounts earned on sale of shares by the appellant would be taxable under the head profit and gains of business and not under the head capital gains. This was after negating the appellants contention that they had subscribed to the shares in M/s. MABL as a strategic investment in an unlisted company. The Assessing officer held that the appellant was not an investor in shares as it had subscribed to the shares in May 2003 out of borrowed funds, which according to him no investor would do. Besides holding that the appellant had subscribed to 20% of the issued equity shares capital of M/s. MABL at the price of Rs.21.30 per share even when the book value of the shares was almost Nil. This according to the Assessing Officer would also not be done by an investor. In the alternative the Assessing Officer held that the consideration received on sale of shares by the appellant was in the nature of compensation for termination of the appellants position as Manager of M/s. MABL. Therefore, the excess received on sale of the shares was consideration received by the appellant for termination/surrender of its management of M/s. MABL and therefore taxable under the head Business Income as provided in Section 28(ii) of the Act. Consequently, the Assessing Officer by order dated 29 December 2008 assessed the income of Rs.10,12,31,340/arising on the sale of shares of M/s. MABL by theto other two shareholders of M/s. MABL as business income.(e) Being aggrieved by the order dated 29 December 2008, the appellant preferred an appeal to Commissioner of Income Tax (Appeals) (CIT(A)). By order dated 29 July 2009 to CIT(A) while allowing the appeal of the appellant assessee relied upon the Shareholders agreement and Subscription agreement both dated 16 May 2002 which regulated and restricted the sale of shares in M/s. MABL The above agreements provided that the sale could only be by any one of the shareholders to any of the other two shareholders during the three yearperiod and even thereafter all the three shareholders would continue to have a right of preemption if any of the other shareholders sought to disinvest/sell its shareholding or part thereof. Further the CIT(A) also held that Shareholders agreement dated 16 May 2002 provided that the appellant would be the Manager of M/s. MABL. On all the above facts it was concluded that the subscription to the shares of M/s. MABL made by the appellant was with intent to running the business of M/s. MABL as a Manager and make it dividend paying company. In any event the CIT(A) also held that the issue arising in the present appeal is covered in favour of theby the decision of the Apex Court in Ramnarain Sons Private Limited vs. CIT (1961) 41 ITR 534   when purchase of shares in excess of market price with object of acquiring managing agency was held to be a capital asset and not stock in trade. So far as borrowed funds was concerned the CIT(A) was held that amount was borrowed from an outside party for a short span of 12 days and the same was without any interest only as a mode of bridge financing. Therefore, the subscription to the shares of M/s. MABL by borrowing of funds was not with a view to leveraging finance but with an intent to hold the shares. In the result, CIT (A) concluded that the intention of the assessee while investing Rs.6.54 crores at Rs.21.30 per share for acquiring 20% shares of M/s. MABL was not with an intention to trade in shares but to acquire the management in M/s. MABL. So far as the application of Section 28(ii) of the Act to the present facts is concerned the CIT(A) held that the amount received on sale of shares is not an amount received on surrendering its right to manage M/s. MABL. Therefore, application of Section 28(ii) of the Act to the present facts is not legally tenable. In these circumstances, the CIT(A) by order dated 29 July 2009 allowed theappeal before it.(f) Being aggrieved by the order dated 29 July 2009 the revenue filed an appeal to the Tribunal. The Tribunal by its order dated 25 April 2012 allowed the revenues appeal holding that the amounts earned on sale of shares is to be brought to tax under the head business income and not under the head capital gains. The basis of arriving at the above conclusion was asIn 2003, when the appellant invested/subscribed to the shares of M/s. MABL having face value of Rs.10/of which the book value was Nil, yet thehad subscribed to 20% share holding in M/s. MABL at the rate of Rs.21.30 per share. Thus, the Tribunal concluded that no investor would purchase share at such high price when there is no return in the offing. Further, shares were purchased/subscribed to from borrowed funds and no investor would purchase shares of loss making company out of borrowed funds when there is no likelihood of earning any dividend income. Consequently, the purchase of shares had only been made with a view to make profits on resale of shares.(ii)) In the shareholders agreement the appellant assessee is described as a Manager because day to day management was entrusted to Mr. R.K. Jain who was also the Managing Director of the appellant and that there is nothing in the shareholders agreement or subscription agreement to indicate that acquisition of 20% share holding in M/s. MABL was condition precedent for the appellant acquiring right to manage M/s. MABL Alternatively, the share holders agreement provided that the the Managing Director will exercise his authority in consultation with the executive committee. Therefore, the appellant assessee did not have any management rights in M/s. MABL. Consequently the subscription to 20% shares of M/s. MABL was not to acquire right to manage M/s. MABL(iii) The decision of the Apex Court in Ramnarain Sons (P) Ltd. (supra) is inapplicable for the reason that in that case investment for purchase of shares was made at price higher than the market price so as to acquire managing agency rights of the company. It was in view of the above fact that the subsequent loss on sale of shares so acquired, the Apex Court held the loss to be capital loss. In the present case, the shares purchased by the appellant assessee does not give the appellant any controlling interest/rights in M/s. MABL Therefore, there is no justification to purchase at so high a price. Thus, by its order dated 25 April 2008 the Tribunal concluded that subscription to shares of M/s. MABL by the appellant was only with the intention to make profit from resale of the shares. Therefore, any profit arising therefrom was chargeable to tax under the head profit and gains of business and not under the head capital gains.7) Being aggrieved by the order dated 25 April 2012 of Tribunal the appellant assessee is in appeal before us on the two substantial questions of law referred to herein above.

Reasoning:
15) Therefore, taking all the cumulative factors including the decision of the Supreme Court in Ramnarain Sons (P) Ltd. (supra) the impugned order was incorrect in holding that 20% shares of M/s. MABL subscribed to by the appellant was stock in trade of the appellant and not its capital asset, as contended by the revenue.16) So far as question No.2 is concerned, the impugned order proceeds on the basis that 20% of the equity shares, which were subscribed to by the appellant in M/s. MABL at a price much higher than its book value which was Nil and out of borrowed funds would by itself indicate that the subscription made by the appellant was not as an investment but as a trader in shares. This finding of the Tribunal is perverse for the reason that purchase of shares at a price higher than book value cannot be itself lead to the conclusion that the purchase was not in the nature of investment. It is a well known global phenomena that investors purchase shares of loss making companies because in their perception the company has inherent potential to do well either on account of its business model or on account of the management of the company. The potential perception is unique to each investor and there cannot be any universal yard stick to determine whether such perception was justified or not. In any case the other two subscribers in the shares of M/s. MABL had subscribed at the price of Rs.87.95 per share (S&N) and Rs.35.83 per share (UB) itself evidences the fact that others had also perceived great investment opportunity in the business of M/s. MABL The submission on behalf of the revenue that this particular argument with regard to investment being made by other two subscribers at a higher price was not brought to the notice of the Tribunal during the hearing, though not disputing that the same was part of the record and proceeding before the Tribunal. The analogy drawn on the basis of the explanation under Section 147 of the Act may not be a proper analogy. In any view of the matter, it is not necessary to resolve the above issue as the respondent revenue do not deny/dispute before us that the shares were subscribed to by S&N at Rs.87.95 per share and by UB at Rs.35.83 per share. Therefore, the fact that other share holders have subscribed at higher price is an undisputed position. This would also establish that perception of the potential of the M/s. MABL on the part of the appellant was not solitary and unique. To our mind even if the perception of the appellant was solitary and unique, it would make no difference.17) Be that as it may, even if the price at which the shares were subscribed to were higher than its book value that again by itself would not lead to the conclusion that in such cases purchase has been done not by investor in share but by trader in shares. On the contrary the investor in shares would in the normal course hold shares for a longer period of time even in liquor business (though not affected by business cycle prevailing in most of the industries) as time would be taken to establish a place in the market. Therefore, the scrip may become profitable over a period of time. In contrast a trader in shares normally holds shares for a shorter period of time and looks for quick returns. In such circumstances, he is less likely to purchase share at price higher than the market value and in case of unquoted shares at a price higher than its book value. Therefore, test applied by the Tribunal in the impugned order to hold that subscription of 20% shares in M/s. MABL at a higher price then the book value of the equity shares to conclude that the appellant is a trader, is perverse.18) Similarly the finding in the impugned order that because the shares were subscribed to by the appellant from borrowed funds the subscription/ purchase of shares cannot be said to be an investment, is perverse. In the facts of this case, the appellant had borrowed funds from an outside source ( that is not from group companies) only for a period of 12 days without interest. Thereafter, the appellant had sourced its funds by subscription of its shares by its group company one Feedback Computers Ltd. in which substantial share holder to the extent of 83.93% was one Mr. R.K. Jain who holds 99.99% shares in the appellant company. Moreover, whether or not a particular purchase/subscription to shares was for the purpose of doing business or for purpose of investment cannot be determined on the basis of whether the amount required for the purchase of the same was borrowed or self generated funds. It is well known that capital assets, at times are acquired out of borrowed funds and the distinction between capital assets and stock in trade is not on the basis of source of funds i.e. borrowed funds or self generated funds but on the basis of assets itself and for the period for which it is held before the same is traded/sold. Thus, the finding of the Tribunal that the subscription to the extent to 20% in the equity shares of M/s. MABL was for trading in shares because the payment was not out of its own funds, is perverse.19) Similarly, the impugned order holds that though the appellant had right to appoint its nominee as a Manager of M/s. MABL yet the nominee could not exercise authority as a Manager on his own but had to do so in consultation with others and therefore was not the Manager. Consequently, the conclusion by the Tribunal that no amount was paid while subscribing for the shares to enjoy the rights of Manager of M/s. MABL. Merely because the appellants nominee acts as Managing Director of M/s. MABL and such function of Managing Director as a Manager has to be discharged in consultation with others does not denude the Manager of its authority and function as a Manager. It is axiomatic that no Manager in any field of business activity enjoys on absolute and unfettered rights to manage his business without having to consult others. Therefore, the finding in the impugned order that because the appellant nominee has no absolute right to manage M/s. MABL as it desires, it must follow that the appellant has no right as a Manager of M/s. MABL, is perverse.20) We shall now answer the two substantial questions of law which were admitted for our consideration asNo.1 – In the negative i. e. in favor of the appellant – assesses and against the revenue.Question No.2 – In the affirmative i. e. in favor of the appellant – assessee and against the revenue.