ORDER
Sunil Kumar Yadav, Judicial Member
1. These appeals are preferred by the Revenue on common ground that the CIT (A) has erred in directing the Assessing Officer to treat the profit on sale of shares under the head long term capital gain, where as the Assessing Officer had segregated the capital gain income as shown by the assessee in the return of income into business income and capital gain for the detailed reasons given by him in the assessment order.
2. Since, these appeals were heard together, we prefer to adjudicate them by this consolidated order. Since the facts of both the appeals are on common, we take up the facts of the case in ITA. No. 6374/Mum/2004 in order to understand the issue involved and also to adjudicate it.
2.1. The facts in brief borne out from the Orders of the lower authorities in ITA. No. 6374/Mum/2004 are that the assessee in the return of income had shown long term capital gain on sale of shares of Rs. 4,85,30,780/- for which statement of working of long term capital gain was attached with the return of income. The said statement included capital gains on sale of shares at Rs. 5,90,15,240/-, which were converted into investment from stock in trade on 1-4-1998 (relevant for the assessment year 1999-2000). During the course of assessment proceedings, the Assessing Officer asked the assessee to furnish details in respect of said shares and also to clarify whether any of these converted shares were sold during the year under consideration. In reply thereto, it was stated through letter dated 12th March, 2003 that there are only long term capital gain arise on sale of said shares and not the business income. The entire details are furnished before the Assessing Officer.
2.2. Being not convinced with the explanation of the assessee, the Assessing Officer held that in view of principles of laid down under Section 45(2) of the Act, the income of the assessee would be computed separately as business income till the date of conversion of the shares from the stock to investment and thereafter as long term capital gain. Accordingly, he has taken the highest market rate of the said shares as on 1-4-1998 (date of conversion) and computed the business income at Rs. 1,32,52,978/-, being the difference in the value at which the said shares were converted into investment and the market value of the said shares on the date of conversion i.e., 1-4-1998 and computed the long term capital gain at Rs.4,57,62,262/- being the difference between the market value and the actual sale value of the shares.
2.3. Aggrieved the assessee preferred an appeal before the CIT (A) and made detailed submissions along with the details of shares which are reproduced by the CIT (A) in his order. For the sake of reference, we extract the same as under:
1. The return of income for the assessment year in question was filed on 30-11-2000 declaring the total income of Rs. 13,14,91,388/- which was computed under the head business income as well as capital gains. The return of income was accompanied by audited accounts as well as tax audit report Under Section 44AB of the I.T, Act. (Refer page No. 1 to 11 of the paper book).
2. The total income consist of long term capital gain on sale of shares at Rs. 4,88,30,780/-. We enclose statement of working of the said long term capital gain (Refer page No. 2 of paper book). The said statement includes long term capital gain at Rs. 5,90,15,2440/- on sale of shares which were coverted into investment from stock in trade on 01-04-1998 (A.Y. 1999-2000) and a note to that effect was also given in the notes of accounts of the schedule of the balance sheet and profit and loss account for the said assessment year, (refer page No. 12 to 18 of the paper book). The learned Assessing Officer assessed the said capital gain into two parts one as a business income and another as capital gain as per the details given in the subsequent paras.
3. During the course of assessment proceedings the teamed Assessing Officer asked appellant to furnish the details in respect of the shares which were converted into investment and also asked to clarify as to why the capital gain on sale of such shares should not be recomputed by segregating it into business income and long term capital gain in term of the principles laid down Under Section 45(2) of the I.T. Act In reply thereto, appellant’s representative vide letter dated 12/03/2003 submitted the complete details and also strongly objected to re-compute the long term capital gain in the above manner. A copy of the said letter is enclosed in the paper book, (refer page No. 19 to 28 of the paper book). We herein below give the summarized contents of the said letter.
a) Assessee company converted following scrips of stock in trade of shares as on 01-04-1998 into investment at its book value by passing necessary Board Resolution and entries in the books of accounts, since the same were intended to be hold for longer period and in the balance sheet it has been shown under investment account being capital asset of the company.
Sr. No. Name of the Company No. of Value as on
Shares 01/04/98
1. Birla 3M 106600 18382255.00
2. Infosys Tech (Bonus) 11500 __
3. International Best Foods 41950 4679190.50
4. Nestle India Ltd. 100950 25042610.00
5. Nestle India Ltd. (Bonus) 41975 --
6. Novartis India Ltd. 7900 2746843.75
7. Wyeth Lederie 9991 4227691.65
________ _____________
320866 55078590.90
b) During the assessment year under consideration assessee company sold following scrips which resulted into long term capital gain.
Name of Scrip Qty Cost Sale Price Capital
gain/Loss
Infosys Technology Ltd. 6000 --- 57762440 57762440
Nestle India 350 123079 154682 31603
Novartis India Ltd. 150 52837 173620 120783
Wyeath Lederral Ltd. 9991 4227692 2966828 1260864
International Best Food 41950 4679191 7040468 2361277
9082799 68098038 59015239
The above scrips were sold after the period nearly 23 months and certain scrips were still held under investment portfolio even after completion of 5 years from the conversion of the said shares.
c) Inspite of rise in the price of the scrips of these shares assessee did not sale the same and book the profit on the very first opportunity rather continued to hold the said shares under investment portfolio of rise and fall in the price for which necessary details also submitted.
d) No trader would have hold his stock in trade of shares for such a long period which clearly give the indication that the shares were held for investment portfolio.
e) The circumstances under which the assessee company decided to sale some of the converted shares were satisfactorily explained.
f) The conversion of shares from stock in trade to investment does not give any profit,. which arised only in the fixture when the said investment is sold.
g) Provisions of Section 45(2) cannot be applied in case of assessee since it applies to the cases of other way round i.e. conversion of investment into stock in trade.
h) Reliance in support of the same was placed on the following decisions:
i. Sir Kikabhai Premchand v. CIT (1952) 24 ITR 506 (SC).
ii. CIT v. Dhanuka and Sons 24 ITR 24 (Cal.)
4. The learned A.O. however summarily rejected the contention raised by the appellant and segregated the long term capital gain on sale of converted share at Rs. 5,90,15,240/- into business income at Rs. 1,32,52,978/- being the difference in the market value and the book value of the said shares on the date of conversion and balance Rs. 4,57,62,262/- as long term capital gain by applying the principles laid down under Section 45 (2) of the Income Tax Act The working of the said segregation is given herein below which is also given at para No. 10 of the assessment order.
Name script Date of Qty Sold Cost of Market Business Sale Long term
of the sale conversion price as on Profit/loss proceeds capital
as on 1/4/98 gain/loss
1/4/98
1. 2. 3. 4. 5. 6. 7. 8.
Infosys Tech. Mar.00 6000 NIL 11610000 11610000 57762440 46152440
Ltd.
Nestle India Apr. 99 350 123079 159775 36696 154682 -5093
Novarties India Sep. 99 150 52837 47126 -5712 173620 126495
Ltd.
Wyeath Lederaf Mar. 00 9991 4227692 4855626 627934 2966828 -1888798
Ltd.
International Mar. 00 41950 4579191 5653250 984509 7040468
Best Foods Ltd.
58441 9082799 22335777 13252978 68098038 45762262
5. In this context at the outset it is submitted that the Learned Assessing Officer totally misconceived the provisions of Section 45(2) of the Income Tax Act and therefore wrongly applied the principles laid down in the said section in appellant’s case and recomputed the income in the above manner.
3. The CIT (A) re-examined the issue in the light of relevant provisions of the Act and various judgments referred to by him and has observed that assessee has converted some scrips from stock in trade to investment as on 1st April, 1998 at its book value. Thereafter, some of the scrips were sold out of the above (nearly after 23 months) and the gain was declared by the assessee as a long term capital gain and tax was paid accordingly. With regard to applicability of Section 45(2), the CIT (A) has observed that this section has a specific provision for computation of income when a person converts investment into stock in trade and subsequently sells such stock in trade. Whereas, the assessee’s case is other way round i.e., it has converted its stock in trade to investment and as such, apparently Section 45(2) of the Act does not have any applicability in the instant case. After having examined various Judgments in the case of Sir Kikabhai Premchand v. CIT (1952) 24 ITR 506 (S.C.), CIT v. Dhanuka and Sons 124 ITR 24 (Cal.) the CIT (A) has observed that the action of the Assessing Officer to segregate “the long term capital gain as shown by the assessee in the return of income, into business- income and capital gain in the manner as discussed in the assessment order, is totally arbitrary and unjustified. He, accordingly, dirccted the Assessing Officer that long term capital gain declared by the assessee, be. accepted. The relevant observation of the CIT (A) is extracted hereunder in this regard:
4.6. After careful consideration of the entire facts an record and in view of detailed discussion held above, I am of the opinion that the action of the Ld. Assessing Officer to segregate the long term capital gain as shown by the appellant in the return of income, into business income and capital gain in the manner as discussed in the assessment order is totally arbitrary and unjustified. The provisions laid down under Section 45(2) of the Act are absolutely clear and applicable only in the case when investment is converted into stock in trade and not vice-versa. In the absence of specific provisions under the Act in this regard. The presumption of Assessing Officer to recompute the income other way round is not justified. The cases relied upon by the Ld. A.R. also support the action of the appellant in totality. In the case of CIT v. Dhanuka and Sons 124 ITR (Cal.) it has been categorically held that profit and gains on shares transferred from trading account to investment account at prevailing market rate is not a transaction at all because a person cannot have a transaction with himself and in turn such profit cannot be taxed. If such shares be disposed of at a value other than the value at which it was transferred from the business stock, the question of capital loss or capital gain would arise.
In view of all above, I hold that the action of the Assessing Officer is not justified. In other words, the long term capital gain declared by the appellant in the return of income on conversion of shares is restored back. As such, the appellant succeeds on this ground of appeal.
4. Now the Revenue has preferred an appeal before the Tribunal with the submissions that the analogy drawn from Section 45 (2) of the Act should be applied in the instant case in which the stock in trade was converted into the investment, in the light of the fact that there is no specific provision in the Act which deal with this type of situation. The learned Departmental Representative has also placed a heavy reliance upon the assessment order.
5. The learned Counsel for the assessee on the other hand has submitted that undisputedly there is no provision in the Act which deals with the determination of business income or capital gain on conversion of the stock in trade into investments, which is later on sold. The learned Counsel for the assessee further invited our attention to the Judgment in the cases of Sir Kikabhai Premchand v. CIT (1952) 24 ITR 506, CIT v. Dhanuka and Sons 24 ITR 24 (Cal.), which were relied on by the CIT (A) while granting relief to the assessee. He has also invited our attention to the Commentary from the book of Law of Income Tax, 10th Edition, Authored by Sampath Iyengar with regard to the conversion of capital assets to the stock in trade. The learned Counsel for the assessee contended that where there is no provision to deal with the present situation, the Assessing Officer has no right or authority to draw his own formula to determine the business income and the capital gain. The assessee itself has taken the book value of the shares as cost of its acquisition on the date of conversion and reduced it after indexation from the sale price of the shares in order to determine the long term capital gain. In the present circumstances, the method adopted by the asscssee is perfect and reasonable and should be accepted by the Revenue. He, accordingly, placed a heavy reliance upon the Order of the CIT (A).
6. Having heard the rival submissions end from careful perusal of the record, we find that the shares held in stock in trade were converted into investment at the book value shown in the books of accounts. Later on, the shares held in investment were sold and the assessee offered the capital gain accrued on the sale of shares. Admittedly, the provisions of Section 45(2) of the I.T. Act, deals with the issue of capital gain where the investment is converted into stock in trade. According to this section, the profits or gains arising from the transfer by way of conversion by the owner of a capital asset into or its treatment by him as stock in trade of a business carried on by him, shall be chargeable to tax as the income from the previous year in which such stock in trade is sold or otherwise transferred by him, and for the purpose of Section 48. fair market value of the asset on the date of such conversion or treatment, shall be deemed to be the full value of the consideration recieved or accruing as a result of transfer of the capital asset. While incorporation the Sub Section 2 to Section 45, the legislature has not visualized the situations in other way round, where, the stock in trade is to be converted into the investments and later on the investment was sold on profit. In the absence of a specific provision to deal with this type of situations, a rational formula should be worked out to determine the profits and gains on transfer of the asset. We are also conscious about the judgments in the cases of Sir Kakabhai Premchand v. CIT (1952) 24 ITR 506 (S.C.), CIT v. Dhanuka and Sons ITR 24 (Cal.) (supra) in which it has been held that there cannot be an actual profit or loss of such transfer when no third party is involved and the items are kept in a different account of the assessee himself. The aquestion of_gain or toss would arise only in future when, the stock transferred to the investment account might be dealt with by the assessee. If such shares be disposed of at a value other than the value at which it was transferred from the business stock, the question of capital loss or capital gain would arise. In the absence of a specific provision to deal with the present situation, two formulas can be evolved to work out the profits and gains on transfer of the assets. One formula which has been adopted by the Assessing Officer i.e., difference between the book value of the shares and the market value of the shares on the date of conversion should be taken as a business income and the difference between the sale price of the shares and the market value of the shares on the date of conversion, be taken as-a capital gain. The other formula which is adopted by the assessee’s i.e., the difference between the sale price of the shares and this cost of acquisition of share, which is the book value on the date of conversion with indexation from the date of conversion, should be computed as a capital gain. In the absence of a specific provision, out of these two formulas, the formula which is favourable to the assessee, should be accepted. We, therefore, of the view that CIT (A) has properly examined this issue in the present situation and directed the Assessing Officer to accept the capital gain offered by the assessee.
7. We, accordingly, confirm his order.
8. Since the facts are similar in ITA. No. 9543/Mum/2004, we decide the issue in the same manner and accordingly, confirm the Order of the CIT (A) in this case also.
9. In the result, appeals of the Revenue are dismissed.
Order pronounced in the open Court, on this the 02nd day of July, 2008.