Case: M/S Khoday Distilleries Ltd Vs. Commissioner Of Income Tax

On 29.1.1986 the appellant company, on the other shareholders not exercising the option given to them to take up the right shares issued by the appellant, allotted them to the seven investment companies, who were the shareholders in the appellants company. At this stage, it may be stated, that in all there were twenty-seven shareholders. Twenty shareholders did not subscribe to the rights issue and consequently the appellant-company allotted them to the remaining existing shareholders. The A.O. held that the said allotment by way of rights issue was without adequate consideration within the meaning of Section 4(1)(a) of the 1958 Act. He further held that the modus operandi was an attempt to evade taxes; that it was a colourable transaction and since the shares allotted were without adequate consideration, there was a deemed gift under Section 4(1) of the 1958 Act. Accordingly, the difference between the value of the shares on yield basis and the face value of Rs. 10/- at which the shares were allotted was sought to be brought to tax under the said section. Aggrieved by the decision of the A.O., the appellant carried the matter in appeal to CIT(A). It was held that the entire exercise undertaken by the appellant was to evade payment of wealth tax by the individual shareholders of the appellant-company. This finding was given by the CIT(A) on the ground that right shares were allotted because 20 existing shareholders out of 27 shareholders of the company did not subscribe for the rights. However, according to the CIT (A), gift tax proceedings had to be initiated by the Department not against the appellant company but it ought to have initiated gift tax proceedings against the existing shareholders who had renounced their rights. Having so held, the CIT(A) came to be conclusion that the entire exercise undertaken by the appellant was to avoid payment of wealth tax and, therefore, it was held that the company was liable to pay gift tax for transfer of the said shares to the seven investment companies. This decision of the CIT(A) stood reversed by the Tribunal which decided the appeal filed by the company against the Department. The Tribunal came to the conclusion that the allotment of rights by the appellant did not constitute "transfer" as it did not involve any existing property at the time of such allotment. According to the Tribunal, the seven investment companies made payment towards the face value of the shares and, consequently, it cannot be said that the contract was without consideration. It was further held that in this case there was no element of gift under Section 4(1)(a) as there was no transfer of property as defined under Section 2(xxiv) of the 1958 Act. Aggrieved by the decision of the Tribunal, the Department preferred Gift Tax Appeal No. 2/02, which, vide the impugned judgment, stood disposed of in favour of the Department, hence, this civil appeal.

Court's reasoning:
In this case,even according to CIT(A), the right shares were allotted to the seven investment companies because the other existing shareholders did not subscribe for the shares. According to CIT(A), the gift tax proceedings ought to have been initiated against the existing shareholders, who had renounced their rights. We are surprised that despite the orders passed by CIT(A), the Department did not initiate proceedings under the Gift-tax Act against the shareholders who had renounced their rights, particularly when the CIT(A) has specifically said so in her order. For the aforestated reasons, we hold that the word "allotment" indicates creation of shares by appropriation out of the unappropriated share capital to a particular person and that such creation did not amount to transfer. That, in any event, liability to pay gift tax would be on the donor (shareholder) who exercises the option to renounce and not on the appellant-company. Accordingly, question no. 1 is answered in favour of the appellant and against theour view, the principle stated by Lord Finlay really resolves the controversy raised in this case. The profits made by the Company may be distributed as dividends or retained by the Company as its reserve which may be used for improvement of the Companys works, buildings and machinery. That will enable the Company to make larger profits. There cannot be any dispute that the shareholders will benefit from the improvements brought about in the profit- making apparatus of the Company. Likewise, if the accumulated profits are capitalised and capital base of the Company is enlarged, this may enable the Company to do its business more profitably. The shareholders will also benefit if the share capital is increased. They may benefit immediately by issue of bonus shares. But neither in the case of improvement in the profit-making apparatus nor in the case of expansion of the share capital of the Company, can it be said that the shareholders have received any money from the Company. They may have benefited in both the cases. But this benefit cannot be treated as distribution of the amount standing to the credit of any reserve fund of the Company to its shareholders.In fact, the transfer of the amounts standing to the credit of development rebate reserve to the share capital account, does not involve any disbursement of money by the Company. Nothing comes out of the till of the Company to the shareholder. The entire amount of money shown as development rebate reserve is retained by the Company in another account. It cannot be said that by the issue of bonus shares, the Company had distributed its reserve fund to the shareholders even though it had retained the entire amount with it in the share capitalstated above, we do not know the reason why the Department had not proceeded under the Income-tax Act, 1961 if, according to the Department, the case was of tax evasion. According to the CIT(A), the appellant had undertaken an exercise to avoid wealth tax whereas according to the A.O. the exercise undertaken by the appellant was to evade Gift Tax and in the same breadth the A.O. states that the entire exercise was to evade tax by allotting shares to the Directors which attracted the deeming provisions of Section 2(22) of the 1961 Act (see page 35 of the Paper Book). There is utter confusion on this aspect. Therefore, in our view, on the question of evasion of tax, the contention of the Department is conflicting. In fact, as stated above, the Department has messed up the entire case. The Department has not kept in mind the difference between "allotment" and "renunciation". The Department has not invoked the provisions of the Gift-tax Act against the renouncer shareholder despite the observation of the CIT(A) in thatof the above aspects has been dealt with by the High Court in its impugned judgment.