ORDER
J.G. Pendse, Accountant Member
1. These appeals filed by the Revenue are against the orders of the CIT(A) dated 18-1 -1989 in the case of Shri R. Krishnaswamy and Minor K. Rajesh, F/G Sri R. Krishnaswamy. These appeals are being disposed of by a common order, as a similar point is involved for decision.
2. The only ground of appeal is that the CIT(A) erred in holding that Shri R. Krishnaswamy and Minor K. Rajesh were entitled to relief of Rs. 2,86,224 and Rs. 1,16,308 taxed as capital gains. The facts are as under:
3. The assessees were holding the shares in Rajalakshmi Mills Ltd., Lakshmi Mills Co. Ltd. and Premier Mills Ltd. and Premier Breweries Ltd. from 1969. On 9-11-1983, both the assessees claimed to have converted the investments held by them into stock-in-trade in the names of M/s. Krishnaswamy Associates and M/s. Rajesh Associates. An affidavit to this effect was filed before the Assessing Officer. On 15-12-1983, the shares were sold to a Private Limited Company known as M/s. R. Krishnaswamy Investments (P.) Ltd. The Assessing Officer held that the transactions converting the investment into stock-in-trade was a colourable transaction and was effected with the sole intention of avoiding capital gains. Hence, based on the decision of the Supreme Court in the case of McDowell & Co. Ltd. v. CTO [1985] 154 ITR 148, he concluded that there was no conversion from investment to stock-in-trade. In this connection the Assessing Officer also observed that M/s. R. Krishnaswamy Investments (P.) Ltd. (the company to whom the shares were sold by the assessees) had only three shareholders, namely, the assessees and Smt. K. Srivalli, wife of Sri R. Krishnaswamy. In the circumstances, he brought the capital gains to tax as long-term capital gains.
4. The CIT(A) held that the transaction was not sham. He also held that R. Krishnaswamy Investments (P.) Ltd. was incorporated on 14-12-1983 with the object of dealing in shares and the company was carrying out regular business in shares. Thereafter the CIT(A) held that in view of the affidavits regarding conversion, there was conversion of the shares from capital assets to stock-in-trade, and he allowed the assessee’s appeals holding that there was no capital gains involved in view of the conversion of the capital assets namely, shares, into stock in trade. The present appeals are against the said decision of the CIT(A).
5. The learned Departmental Representative stated that the CIT(A) has dealt at length the issue and observed that Krishnaswamy Investments (P.) Ltd. had entered into various transactions for shares. He stated that the fact about the business in shares by Krishnaswamy Investments (P.) Ltd. is not disputed and it is also not relevant for the present issue. The present issues relates to the conversion of shares into stock in trade by R. Krishnaswamy and Minor K. Rajesh. He noticed that Krishnaswamy Investments (P.) Ltd. was incorporated on 14-12-1983. The memorandum was signed by Sri Krishnaswamy and his wife Smt. Srivalli and the company was incorporated with the main object of working as an investment company and to sell and deal in shares etc. He further pointed Out that printed articles showed that at page 10 of the memorandum the date was shown as 3-11 -1983. Thus the action had already been taken by the assessees to incorporate the company to deal in shares. The intention was to transfer the shares to the company as soon as the company is incorporated. He further contended that this is supported by the fact that the shares were sold on 15-12-1983, just the next day after incorporation. The affidavits by the assessees for converting the shares into stock-in-trade is dated 9-11-1983. He further stated that the shares of small and meagre amounts were purchased in order to show that Krishnaswamy Associates and Rajesh Associates were dealing in shares. He also invited our attention to the balance sheets of these two firms which read as under:
Krishnaswamy Associates:
Balance Sheet as on 31-12-1983
Liabilities Assets
Capital account:
Rs. Rs.
Cash at bank 571-00
Sri R. Krishna- Stock of shares 26,557-00
swamy (S. HUF) 9,97,150-00
Less: Net loss 15,115-00 Sri R. Krishnaswamy
9,82,035-00 account 9,56,767-00
Current Liabilities:
M/s. S. Subramania
&Co. 1,860-00
Total: 9,83,895-00 Total: 9,83,895-00
for M/s. Krishnaswamy
Associates
Sd/- R. Krishnaswamy
Assessee
M/s. Rajesh Associates:
Balance sheet as on 31-12-1983
Liabilities Rs. Assets Rs.
Capital Account Cash at bank 301-00
Minor, Rajesh 4,99,441.50 Stock of shares s 5,337-50
Less: Net loss 9,386-00 Minor Rajesh
Individual 4,90,142-00
Rs. 4,90,055-50
Current Liabilities:
M/s. S.K. Ranganathan 5,725-00 4,95,780-50
4,95,780-50
for M/s. Rajesh Associates,
Sd/- R. Krishnaswamy
Assessee.
He stated that the capital account of R. Krishnaswamy shows the balance of Rs. 9,97,150 whereas a liability of Rs. 9,56,767 is shown. Similarly the credit balance in the capital account of minor Rajesh would show Rs. 4,99,441-50 and on assets side his individual account show a sum of Rs. 4,90,142. He pointed out that, in accounting these two entries on both assets and liabilities side cannot appear. Admittedly in the case of minor Rajesh there cannot be a debit and credit both appearing in the account. He stated that it is the normal accounting principle that these balances should be netted. If this is done, then R. Krishnaswamy’s balance capital would be Rs. 30,393 and minor Rajesh’s balance capital would be Rs. 9,299. Such low capital should be viewed in the light of their bringing in shares as capital of Rs. 9,97,150 and Rs. 4,99,441 respectively. He pointed out that such reduction in capital is not explained based on the loss incurred by M/s. Krishnaswamy Associates and M/s. Rajesh Associates. No substantial withdrawals were made from the capital account.
6. The Departmental Representative emphasised that in view of the date of incorporation of Krishnaswamy Investments (P.) Ltd. and the preparation of memorandum on 9-11-1983 and the subsequent affidavits of claiming conversion were sham or were merely intended to avoid the capital gains on transfer of shares to Krishnaswamy Investments (P.) Ltd. This was merely a device to avoid the tax that could have arisen on the transfer of shares to Krishnaswamy Investments (P.) Ltd.
7. The assessee’s representative stated that the transactions were genuine. The affidavits were properly made and the genuineness thereof is not disputed. The affidavits were made on due dates. He also emphasised and referred that due notification had been given by them to the Department of Company Affairs, under MRTP Act. In this connection he referred to the letter from Lakshmi Card Clothing Mfg. Co. Ltd. dated 25-7-1988, which reads as under :
We have received a letter from the Government of India, Ministry of Industry, Deptt. of Company Affairs, New Delhi, requesting us to furnish certain particulars as on 1-1-1977, under Notification S.O. No. 368(E) dated 6-4-1988.
We would request you to please send us the total value of assets of your company (vide audited balance sheet before that date with a copy thereof) at the earliest, however, not later than 4th August, 1988.
The assessees’ representative stated that the assessees had taken action to notify under the MRTP Act of the interest. Further he also invited our attention to the bank transactions entered into by Krishnaswamy Associates and Rajesh Associates. He stated that the bank accounts had been opened for these business concerns and to which various payments were routed. He referred to a deposit of Rs. 9,82,040 to the Central Bank of India on 23-12-1983 in the case of Krishnaswamy Associates and Rs. 4,90,443 in respect of Rajesh Associates and stated that these amounts represented the sale proceeds on transfer of shares received from Krishnaswamy Investments (P.) Ltd. The payments had been received from the company and these transactions were genuine. He also stated that the assessees had entered into transactions for business through M/s. Subramaniam & Co. (Members, Madras Stock Exchange Ltd.) where Krishnaswamy Associates had purchased the shares and also they had entered into contract with M/s. S.K. Ranganathan for 50 shares each of Malayalam Plantations and Ennore Foundaries for both Krishnaswamy Associates and Rajesh Associates. He stated that this activity had been carried out in the course of dealing in shares. This was not a sham transaction. The transactions between Krishnaswamy Investments (P.) Ltd. and the assessees were genuine and were supported by the transfer of funds. Everything that was required to be done for setting up of business like filing of declaration for conversion into stock-in-trade, filing ref. notification under the MRTP Act, opening of bank account had been done and there was nothing further required to be done. The transactions were not sham. He, therefore, supported the orders of the CIT(A).
8. We have considered the rival submissions. We find that both the affidavits were made on 9-11-1983. The affidavits listed the shares held by these assessees and also stated the market value as on that date and also the fact that the shares were converted into stock in trade. Para 7 of the affidavit in the case of Sri Krishnaswamy Associates and Rajesh Associates read as under :
R. Krishnaswamy:
7. This declaration is only in respect of the said shares, particulars of which are mentioned hereinabove and the other shares and securities etc., which I am holding as kartha and manager of R. Krishnaswamy smaller HUF as investment will continue to be held by my said smaller HUF as investment in my capacity as kartha and manager of R. Krishnaswamy smaller HUF.
R. Rajesh :
7. This declaration is only in respect of the said shares, particulars of which are mentioned hereinabove and the other shares and securities etc. which I am holding as father and guardian of minor K. Rajesh will continue to be held by me as an Investment.
The above paras show that the conversion was only with reference to the shares and securities mentioned in the affidavits and the assessees continued to hold other shares and securities in investments. The share transactions by Krishnaswamy Associates and Subramanian & Co. make a peculiar position. It was dated 2-11-1983. Obviously this was before the conversion. It shows that the assessee brought 336 shares of Rajalakshmi Mills Ltd. at Rs. 62 each. It also shows that Krishnaswamy Associates bought 306 shares in five lots of 226, 20, 10, 30 and 20 on 3-11-1983, 11-11-1983, 16-11-1983, 17-11-1983 and 6-12-1983. Similarly Krishnaswamy Associates purchased shares by Memo dated 6-12-1983 through M/s. S.K. Ranganathan of 50 shares each of Malayalam Plantations, Ennore Foundaries and Swadeshi Polyester. M/s. Rajesh Associates is stated to have purchased 50 shares each of the above three companies. These purchases were shown as closing stock by Krishnaswamy Associates and Rajesh Associates. The transactions in respect of Rajalakshmi Mills Ltd. is rather peculiar as many of the transactions were prior to the affidavits.
9. Regarding the comments of the Departmental Representative with reference to the entries in the balance sheets, we are inclined to agree that the presentation is erroneous and only the net amount ought to have been shown. Regarding the withdrawal etc., we do not find any reference to the accounts. Thus, the amount of capital that ought to have been reflected is the net capital, i.e., Rs. 30,393 in the case of Krishnaswamy Associates and Rs. 9,299 in the case of Minor Rajesh.
10. It needs to be taken into consideration that the only shareholders for Krishnaswamy Investments (P.) Ltd. are Sri Krishnaswamy, his wife Srivalli and master Rajesh. The memorandum prepared as seen from the printed memo (perhaps the date for lodging the document to the Registrar of Companies is 3-11 -1983) was signed Sri. Krishnaswamy and his wife Smt. Srivalli. The conversion took place on 9-11-1983, the company was incorporated on 14th December and the shares which were converted were sold to the company on 15-12-1983. This shows that there were common efforts by assessees and common intention of setting up of a company to deal in shares. R. Krishnaswamy Investments (P.) Ltd. was accordingly incorporated and which stated functioning and the shares were immediately sold to the company. In our opinion all these transactions should be read together to reflect common intentions. These are transactions by interested parties. We are inclined to agree with the Departmental Representative that the affidavits for conversion were motivated to avoid the taxes arising on capital gains. The affidavits were made subsequent to the preparation and signature of the memorandum and prior to the incorporation of the company.
11. We find that there are no subsequent material transactions to support the intention to carrying on of business in shares. After the sale of shares the effective capital of the assessees in share business set up has been substantially reduced from Rs. 9,97,150 (representing market value of shares brought in) to Rs. 30,393 in case of M/s. Krishnaswamy Associates and Rs. 4,99,441 (representing market value of shares brought in) to Rs. 9,299 in case of M/s. Rajesh Associates. This reduction is not explained by losses incurred in business. The substantial reduction in capital in such short period of less than 2 months does not reflect sound business practice. It also does not show consistency in intentions of carrying on business and conduct of business. The accounts are in tune with reflecting the affairs to suit claim rather than genuine business by the assessees.
12. Admittedly the transactions ceased after incorporating the company and the business in shares was and is being carried on by the company independently.
13. In view of the above, we hold that this is a case where the principle laid down by the Supreme Court in McDowell & Co. Ltd. ‘s case (supra) are applicable and we hold that this is a fit case where the capital gains should be brought to tax and we hold that the transactions, if not sham, were definitely colourable device to avoid the taxes arising on long-term capital gains. Hence, we reverse the orders of the CIT(A) and restore the orders of the Assessing Officer.
14. In the result, the appeals by the Revenue are allowed.