Capital gains: Sections 2(47) and 48: A.Y. 2002-03: Redemption of preference shares amounts to transfer u/s.2(47): Computation: Redeemable preference shares are not bonds or debentures: At time of redemption of preference shares, assessee would be entitled to benefit of indexation u/s.48.

In the A.Y. 2001-02, the assessee redeemed three lakh preference shares (held for 10 years) at par and claimed long-term capital loss after availing benefit of indexation and claimed the set-off of the same against the long-term capital gain on sale of other shares. The Assessing Officer disallowed the claim on the grounds that —

(i) both the assessee and the company in which the assessee held the preference shares, were managed by the same group of persons;

(ii) that there was no transfer; and that the assessee was not entitled to indexation on the redemption of non-cumulative redeemable preference shares. The CIT(A) allowed the claim of the assessee. The Tribunal affirmed the view of the CIT(A).

On appeal by the Revenue, the Bombay High Court upheld the decision of the Tribunal and held as under: “

(i) There is a finding of fact that the transaction was not questioned by the Revenue for over ten years: that both the assessee and the company of which the assessee held redeemable preference shares were juridical entities and the mere fact that both were under common management would not necessarily indicate that the transaction was not genuine. There is no reason for this Court to differ with the finding of the Tribunal.

(ii) The judgment of the Supreme Court in Anarkali Sarabhai v. CIT, (1997) 224 ITR 422/90 Taxman 502 concludes the issue that a redemption of preference shares by a company squarely comes within the ambit of section 2(47), since it amounts to a transfer.

(iii) The second proviso to section 48 provides for indexation where long-term capital gain arises from the transfer of a long-term capital asset. The third proviso, however, stipulates that nothing contained in the second proviso shall apply to long-term capital gain arising from the transfer of a long-term capital asset being bonds or debentures other than capital indexed bonds issued by the Government.

The Assessing Officer was of the view that the principal characteristic of a bond is a fixed holding period and a fixed rate of return. According to him, the four per cent non-cumulative redeemable preference shares which the assessee redeemed also had a fixed holding period and a fixed rate of return and on this basis denied the benefit of cost indexation to the assessee. The entire basis on which the Assessing Officer denied the benefit of cost indexation was flawed and was justifiably set right in the order of the Tribunal.

(iv) There is a clear distinction between bonds and share capital, because a bond does not represent ownership of equity capital. Bonds are in essence interest-bearing instruments which represent a loan. This distinction has been accepted by the Supreme Court in R. D. Goyal v. Reliance Industries Ltd., (2002) 40 SCL 503.

(v) Section 48 denies the benefit of indexation to bonds and debentures other than capital indexed bonds issued by the Government. The four percent non-cumulative redeemable preference shares were not bonds or debentures within the meaning of that expression in section 48. In these circumstances, the Tribunal was correct in its decision to that effect.”