[Khoday Distilleries Ltd. v. CIT and Another, (2008)
307 ITR 312 ((SC)]
On January 29, 1986, the appellant-company, on the other
shareholders not exercising the option given to them to take up the rights
shares issued by the appellant, allotted them to the seven investment
companies, who were the shareholders in the appellant-company. In all there
were twenty-seven shareholders. Twenty shareholders did not subscribe to the
rights issue and consequently the appellant-company allotted shares to the
remaining existing shareholders. The Assessing Officer held that the said
allotment by way of rights issue was without adequate consideration within the
meaning of S. 4(1)(a) of the Gift Tax Act, 1958 (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 u/s.4(1)(a) 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
Assessing Officer, the appellant carried the matter in appeal to the
Commissioner of Income-tax (Appeals). 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 Commissioner of Income-tax (Appeals) on the ground that rights shares were
allotted because 20 existing shareholders out of 27 shareholders of the
company did not subscribe for the rights shares. However, according to the
Commissioner of Income-tax (Appeals), 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 exiting shareholders who had
renounced their rights. Having so held, the Commissioner of Income-tax
(Appeals) came to the 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 Commissioner of Income-tax
(Appeals) stood reversed by Tribunal which decided the appeal filed by the
company against the Department. The Tribunal came to the conclusion that the
allotment of rights shares 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 u/s.4(1)(a) as there was no transfer of property
as defined u/s. 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.
On an appeal by the assessee, the Supreme Court held that
there is a vital difference between ‘creation’ and ‘transfer’ of shares. As
stated hereinabove, the words ‘allotment of shares’ have been used to indicate
the creation of shares by appropriation out of the unappropriated share
capital to a particular person. A share is a chose-in-action. A
chose-in-action implies existence of some person entitled to the rights in
action in contradistinction from rights in possession. There is a difference
between issue of a share to a subscriber and the purchase of a share from an
existing shareholder. The first case is that of creation, whereas the second
case is that of transfer of chose-in-action. In this case, when twenty
shareholders did not subscribe to the rights issue, the appellant allotted
them to the seven investment companies, such allotment was not transfer. In
the circumstance, S. 4(1)(a) was not applicable as held by the Tribunal.
The Supreme Court further held that there is a difference
between ‘renunciation’ and ‘allotment’. In this case, the Department has
confused the two concepts. The judgment of the Madras High Court in the case
of S. R. Chockalingam Chettiar, (1968) 70 ITR 397 dealt with the case of
renunciation in which case under certain circumstance the renouncer could be
treated as a donor liable to be taxed u/s.4(1)(a) of the Gift-tax Act, 1958.
That was not the situation here. The Department had sought to tax the
appellant-company as a donor under the 1958 Act for making allotment of rights
shares. The Department had not taxed the renouncer shareholders despite the
decision of the Commissioner of Income-tax (Appeals). Allotment is not a
transfer. Moreover, there is no element of existing right in the case of
allotment as required u/s.2(xii) of the 1958 Act. In the case of renunciation
for inadequate consideration in a given case S. 4(1)(a) could stand attracted.
However, in such a case, the Department has to proceed against recouncer
(shareholder). For the above reasons, the judgment of the Madras High Court in
S. R. Chockalingam Chettiar’s case (1968) 70 ITR 397 had no application.
The second issue to be decided by the Supreme Court was
whether there was an element of ‘gift’ in the appellant issuing bonus shares
in the ratio of 1 : 23 in April/May, 1986. In addition to the levy of gift-tax
on the allotment of rights shares, the Assessing Officer levied gift tax on
the bonus shares issued later by the appellant. The Supreme Court held that
when a company is prosperous and accumulates a large surplus, it converts this
surplus into capital and divides the capital amongst the members in proportion
to their rights. This is done by issuing fully paid shares representing the
increased capital. Shareholders to whom the shares are allotted have to pay
nothing. The purpose is to capitalise profits which may be available for
division. Bonus shares go by the modern name of ‘capitalisation shares’. If
the articles of a company empower the company, it can capitalise profits or
reserves and issue fully paid shares of nominal value, equal to the amount
capitalised, to its shareholders. The idea behind the issue of bonus shares is to bring the nominal share capital into line with the excess of assets over liabilities. A company would like to have more working capital, but it need not go into the market for obtaining fresh capital by issuing fresh shares. The necessary money is available with it and this money is converted into shares, which really means that the undistributed profits have been ploughed back into the business and converted into share capital. Therefore, fully paid bonus shares are merely a distribution of capitalised undivided profit. It would be a misnomer to call the recipients of bonus shares as donees of shares from the company. 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 company’s 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 profit-making apparatus of the company. Like-wise, 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 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.
One of the points raised on behalf of the Department before the Supreme Court was that the entire exercise undertaken by the appellant constituted tax evasion. According to the Department, by a paltry investment of Rs.10 lakhs (approximately) the seven investment companies became owners of 24,00,168 shares of M/s. Khoday Distilleries Ltd. worth Rs. 2,40,01,680. According to the Department, the market value of the said shares and the yield from the said shares were totally disproportionate to the investment made by the seven investment companies. Therefore, according to the Department, the modus operandi adopted by the appellant was an exercise in tax evasion. The Supreme Court observed that it does 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 Commissioner of Income-tax (Appeals), the appellant had undertaken an exercise to avoid wealth-tax, whereas according to the Assessing Officer the exercise undertaken by the appellant was to evade gift-tax and in the same breath the Assessing Officer states that the entire exercise was to evade tax by allotting shares to the directors which attracted the deeming prevision of S. 2(22) of the 1961 Act. According to the Supreme Court there was utter confusion on this aspect. The Supreme Court, therefore, was of the view that on the question of evasion of tax, the contention of the Department was conflicting and in fact, the Department had messed up the entire case.
The Supreme Court, therefore, set aside the judgment of the High Court and the civil appeal filed by the assessee was allowed.
