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Income‑tax Reference No. 30 of 1956, decided on 4th September 1956.
Ss. 12‑B (2)‑Capital gains‑Sale of shares and managing agency right‑Composite consideration for shares and managing agency‑Price of shares fixed at much higher rate than market value‑Basis of computation of capital gain- Inflated value or market value‑"Full value", meaning of.
A firm purchased the managing agency rights and 4,736 shares held by another firm in a certain company for a consideration of Rs. 7,51,000 in the year 1938. In 1946, this firm sold to a third party 65,012 shares held by it in the company together with its managing agency right for an amount calculated at Rs. 65 per share, though the market value of the share at the time was only Rs. 46 per share. The Income‑tax authorities held that for the purpose of computing under section 12‑B the capital gain made by the assessee who was a partner of this firm by the transaction "the full value of the consideration for the sale of the shares" must be taken to be Rs. 65 per share, while the contended that the full value was only market value of the share at the time and that his firm had fixed an inflated value for the shares as it parted with its managing agency also. The Tribunal found that the main object, if not the only object of the sale was to get the purchasers appointed as managing agents and that the transaction was not an ordinary sale of shares, ant it found further that the market value on the date of transfer was only Rs. 46, but rejected the assessee's contention as the parties had not apportioned the price to the shares and the managing agency:
Held : (i) that as the consideration received by the assessee's firm was really a composite consideration for transfer of the shares and the assignment of managing agency, and as it was not disputed that the real market value of the shares at the time of the sale was only Rs. 46 per share, for the purposes of section 12‑B (2) the sale price of the shares should be taken at Rs. 46 per share and not Rs. 65 per share, even though the assessee had fixed the consideration for the transfer on the basis of an inflated value for the shares without apportioning the consideration between the shares and the managing agency;
(ii) the Income‑tax authorities were not entitled to claim that the capital gain made by the assessee's firm in respect of the transfer of the managing agency, must also be brought to tax, as they had never set up such a case nor sought to assess the capital gains made by the transfer of the managing agency ;
(iii) that, in view of the third proviso to section 12‑B (2), as the assessee's firm had acquired the shares before the 1st January 1939, the Income‑tax authorities were not entitled to claim that the purchase price of the shares to the assessee's firm should also be determined on the same basis.
These are two applications, made under section 66 (1) by two assessees, Shri Baijnath Chaturbhuj and Shri Radhakrishna Baijnath, who are related to each other as father and son. But for the number of shares held by each, other facts are identical.
Their appeals were heard together and these two reference applications seek to refer to the High Court identical questions of law. Hence they can be conveniently consolidated together. By his application, Shri Baijnath Chaturbhuj (hereafter referred to as the assessee) requires the Appellate Tribunal to refer to the High Court as many as 11 questions of law which are said to arise out of the Tribunal's order, under section 33 (4) in I. T. A. No. 939 of 1954‑55. Inasmuch as, in our opinion, a question of law does arise out of the aforesaid order, we hereby draw up a statement of the case and refer it to the High Court of Judicature at Bombay. Parties agree that all the relevant facts are correctly stated and that there is no omission of any material fact. The Department accepts the question as framed but the assessees desire that all the eleven questions as set out in their applications be referred. We see no reason to do so. A copy of the said questions is Annexure "A" and forms part of the case.
2. The two assessees, Baijnath and Radhakrishna held respectively 6,689 and 7,995 shares of Gujarat Cotton Mills Co. Ltd. These shares were sold and the Income‑tax Officer brought to tax certain amounts as capital gains under section 12‑B of the Indian Income‑tax Act (hereafter referred to as the Act). The dispute relates to the determination of the quantum of the said capital gains in each case.
3. Early in 1938, the managing agency of the Gujarat Cotton Mills Co. Ltd. (hereinafter referred to as the company) was held by the firm of Shantilal Bhagwandas & Co., by an agreement dated 18th January, 1938, the said firm agreed to assign their right of managing agency and their rights and titles under certain other agreements to Sheth Peeramal Chaturbhuj and also to transfer 4,736 shares of the company for a consideration of Rs. 7,51,000. Actually there was, no assignment of the rights of managing agency but the partners of Shantilal Bhagwandas & Co., voluntarily resigned office of the managing agents. Thereafter the company appointed by a special resolution Messrs Peeramal Girdharlal & Co. as its managing agents on certain terms and conditions and a formal agreement was entered into on 28th February, 1938, between the two. At that time the firm of M/s. Peeramal Girdharlal & Co. (hereafter referred to as the firm) consisted of 11 partners. Two clauses, viz., clauses 1 and 14, of the agreement dated 28th February, 1938, are material. A copy of this agreement is Annexure B' and forms part of the case. Clause I fixed the period of managing agency for 20 years certain and it was competent for the managing agents to resign their office within that time without any claim for compensation after giving one month's notice. Clause 14 enabled the managing agents to "assign this agreement and the rights of the managing agents hereunder to any person, firm or company" and the company was "bound to recognise the person or firm or company aforesaid as the managing agents of the company ............for the then residue of the term outstanding under this agreement." The constitution of the firm of Peeramal Girdharlal & Co. underwent slight changes but it continued to hold the managing agency till about September, 1946. On 7th September 1946, an agreement was made between 11 partners of the said firm on the one hand and the firm of Messrs Chaturam & Sons (hereafter referred to as the purchasers). A copy of this agreement is Annexure C' and forms part of the case. The said agreement provided for the sale of 65,012 shares of the company by the firm to the purchasers, and also for the appointment of the purchasers as managing agents of the company on certain terms. The said 65,012 shares were held by as many as 25 shareholders as detailed in the list A' given in the said agreement. It was common ground that they all belonged to the then 11 partners of the firm. Out of the said 65,012 shares Baijnath held 6,689, and Radhakrishna 7,995 shares respectively. The payment for the shares was to be made to 11 partners in accordance with the number of shares held by them m their own names or in the name of their nominees. The Tribunal was told that the proportion of the individual holdings of 11 persons corresponded more or less to their profit‑sharing proportion. Clause 3 of the said agreement made on 7th September 1946, is as follows:
"The vendors shall sell the said shares mentioned in the list A' hereto and the purchasers shall purchase the said shares at or for the price of Rs. 65 per each such share."
Clause 1 provided, that the vendors (i.e., the 11 partners of the firm) shall before 15th November 1946, resign their office as managing agents of the company under the managing, agency agreement dated 28th February 1938, conditional upon the company appointing the said purchasers or their nominees as managing agents of the company for a period of 30 years from the date of such appointment and "upon the same terms as to remuneration and otherwise as are contained in the said managing agency agreement and also conditional upon the purchasers completing the purchase", referred to in clause 3 reproduced above. Other material clauses are 2, 4, 6 and 11. Clause 11 provided that if the purchasers or their nominees were not appointed the managing agents of the company on the agreed terms then the "agreement shall stand cancelled" and "the provisions hereinbefore contained for the sale purchase of the said 65 012 shares . .shall be treated as null and void." An extraordinary general meeting of the company was held on 30th October 1946, and several resolutions, some special and others ordinary, were passed. By special resolution No. 1, which is Annexure 'D' and forms part of the case, the company accepted the resignation of the firm conditional upon the company appointing Messrs Chaturam & Sons as managing agents of the company and also conditional upon the said Messrs Chaturam & Sons completing purchase of 65,012 shares of. The company belonging to the partners of Messrs Peeramal Girdharlal & Co., as provided in the agreement dated 7th September, 1946, made between the said partners and Messrs Chaturam & Sons. By special resolution No. 2 which is Annexure E' and forms part of the case, the firm of Chaturam & Sons was appointed the managing agents in accordance with the agreed terms.
4. Section 12‑B (2) provides for computing the amount of capital gain and stands as follows:
"(2) The amount of a capital gain shall be computed after making the following deductions from the full value of the consideration for which the sale, exchange or transfer of the capital asset is made, namely :‑
(i) expenditure incurred solely in connection with each sale, exchange or transfer ;
(ii) the actual cost to the assessee of the capital asset, including any expenditure of a capital nature incurred and borne by him in making any additions or alterations thereto, but excluding any expenditure in respect of which any allowance is admissible under any provision of sections 8, 9, 10 and 12 .........
Provided further that where the capital asset became the property of the assessee .... ....before the 1st day of January 1939, he may, on proof of the fair market value thereof on the said date to the satisfaction of the Income‑tax Officer, substitute for the actual cost such fair market value which shall be deemed to be the actual cost to him of the asset "
In accordance with this proviso the actual cost of some shares is Rs. 20 and of some others Rs. 15 and there is no dispute as to either of these two figures. The Department has computed the capital gain by taking the difference between the sale price of the shares at the rate of Rs. 65 per share and their actual cost. The figure of the capital gain in case of each of the two assessees thus computed is also not in dispute if the sale price of the shares is to be taken at the rate of Rs. 65 per share.
5. It was not the contention of the assessee that under the provisions of section 12‑B (2) itself the assessee was entitled to a deduction "from the full value of consideration for which sale of the capital asset is made". The contention was this : the market value of the shares sold was Rs. 45 on 3rd September 1946, and Rs. 46‑8‑0 on 10th September 1946, and hence the excess of the price of Rs. 65 per share over its market value of Rs. 46 or so prevailing on 7th September 1946, when the agreement for sale of the said shares was executed, should be attributed to the relinquishment of the managing agency rights which were to be surrendered in‑ accordance with the terms and conditions of the said agreement. The Tribunal found as a fact that the market value of the said share was Rs. 46 or so. The Tribunal, however, rejected this contention for the reasons stated in its order dated 12th August 1955, in I. T. A. No. 939 of 1954‑55 which is Annexure F' and forms part of the case. On the view the Tribunal took of the above‑mentioned contention, it did not find it necessary to go into certain other questions as mentioned in paragraph 8 of the said order.
6. Out of the facts stated above, the following question of law arises:
"Whether for the purpose of computing capital gain in accordance with the provisions of sections 12‑B (2) of the Act, the sale price per each share should be taken at Rs. 65 or Rs. 46 "
N. A. Palkhivala for the Assessee.
G. N. Joshi with Advocate‑General for the Commissioner.
‑In 1938 the managing agency of the Gujarat Cotton Mills Co. Ltd. was held by the firm of Shantilal Bhagwandas & Co and by an agreement dated 18th January 1938, this firm agreed to assign the managing agency and 4,736 shares of the company to Peeramal Chaturbhuj for a consideration of Rs. 7,51,000. On the 7th September 1946, Peeramal Girdharlal & Co. entered into an agreement with Messrs Chaturam & Sons and by this agreement Peeramal Girdharlal & Co. agreed to relinquish their managing agency rights and to get Messrs Chaturam & Sons appointed the managing agents. The agree ment also provided that the vendors shall sell 65,012 shares of the company to the purchasers at the price of 65 per share. Now, the assessee is a partner in Peeramal Girdharlal & Co. and the Taxing Department sought to assess him to tax in respect of capital gains for the assessment year 1948‑49 and what was contended by the Department was that for the purpose of capital gains the sale price of each share should be taken at Rs. 65, the price mentioned in the agreement. On the other hand, the assessee contended that the market value of these shares on the 7th September 1946, was Rs. 46 per share and that was the proper price which should be taken into consideration for determining what capital gains had been made by the assessee. The Tribunal accepted the contention of the Department and the assessee has come on this reference.
Now, the Tribunal has found as a fact, and there can be no dispute about it, that the main object or rather the only object of the agreement of the 7th September 1946, was to get the purchasers of these shares appointed the managing agents of the company. The Tribunal also points out in its order that this was not an ordinary agreement of purchase and sale of shares of the company entered into in the ordinary course of business, and the only reason why it has rejected the assessee's contention was that the parties did not apportion the price of Rs. 65 to the shares and to the managing agency. Under section 12‑B (2) for the purpose .of computing capital gain the full value of the consideration for which the sale, exchange or transfer of the capital asset is made lias to be taken into account, and the short question that we have to consider is : What is the full value of the shares which were sold by the assessee and in respect of which he made a capital gain It is erroneous to suggest that the full value is necessarily the value which the parties place upon a capital asset. The full value must be the true value, not any artificial value, which parties for any purpose may assign to a particular capital asset. Here we have evidence that these shares were marketable and they had a market price which was Rs. 46 per share. The agreement also makes it clear that it was a composite agreement by which not merely the shares were being sold but the shares and the managing agency rights. Therefore, the consideration paid by the purchasers, viz., Rs. 65 per share, was not the consideration paid for the shares alone but it was a consideration that was paid for the shares and also for the relinquishment of the managing agency by the vendors. It is therefore not possible to accept the contention that the full value of shares within the meaning of section 12‑B (2) of the Act was Rs. 65 per share. The full value was the market value of Rs. 46 per share and an additional amount was paid by the purchasers because they obtained not only the shares but also the important right to manage the Gujarat Mills Co. Ltd. It is difficult to understand how the mere fact that the parties have not apportioned the consideration between the two assets which were being dealt with by this agreement can make any difference to the rights of the parties. The position might have been different if the market value of the shares could not be ascertained. Then it might be said that it is difficult to put a proper value upon the shares and to put a proper value for the consideration of the assignment or relinquishment of the managing agency. But when the market value is available and when it is known for what price these shares could be purchased or sold, there is no difficulty whatsoever in the apportionment.
Mr. Joshi's contention is that the capital asset which was being sold and in respect of which capital gain was made was not merely the shares but also the managing agency agreement, and therefore if Rs. 65 were obtained by the purchasers they obtained it in respect of the capital asset and the whole of the capital gain must be brought to tax. Now, it is not the case of the Taxing Department and it has never been their case that the capital asset in respect of which capital gain was made by the assessee and which is sought to be taxed was the shares and the managing agency. The whole of the reference is based upon the fact that the only capital asset we are concerned with is the shares and not the managing agency. Therefore, we must separate the managing agency from the shares considering what is the value to be put upon the shares. Let us test the attitude taken up by the Department from this point of view. Assuming that the parties had put Rs. 5 or Rs. 10 as the value of the shares and they had valued the managing agency for the balance of the consideration, would the Department have accepted the artificial value put by the parties upon the shares if that value was far below the market value The position is the same here. The parties have put upon the shares a value which is much higher than the market value. Admittedly, it is an artificial value and it is artificial because the value put upon the shares is not the value of the shares alone but it is the composite consideration paid by the purchasers for obtaining the shares and also acquiring the managing agency. Under the circumstances, in our opinion, for the purposes of section 12‑B (2) the sale price of the shares should be taken at Rs. 46 per share and not Rs. 65 per share.
A question was also raised that, if that be so, the purchase price to the assessee of these shares should also be determined on the same basis and for that purpose the value of the shares when they were transferred in 1938 should be taken into consideration. Now, the assessee is protected there by the proviso to section 12‑B (2) and that proviso gives him to option, that where the capital asset became the property of the assessee before the 1st day of January 1939, he may substitute for the actual cost such fair market value which shall be deemed to be the actual cost to him of the asset on that date. Here, the assessee has exercised the option and he wants the purchase price to be taken as the fair market value prevailing on the 1st January 1938. In doing so, the assessee is within his rights and the Department cannot insist that the assessee should be compelled to treat as the purchase price the actual cost of the shares in January 1938.
Therefore, the answer to the question submitted to us will be that the sale price per each share should be taken at Rs. 46. The Commissioner to pay the costs of the reference.
No order on the notice of motion. No, order as to costs.
Reference answered accordingly.
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