Court Voids Share Transfer During Liquidation, Denies Capital Loss Claim

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Case Name: 

Bijal Investment Co. (P) Ltd. vs Income Tax Officer (High Court of Gujarat)

Tax Appeal No. 827 of 2006

Date: 24th June 2016

Key Takeaways:

1. Transfers of shares in a company under liquidation are generally void without court permission.

2. The Income Tax Act's definition of "transfer" doesn't override company law restrictions.

3. When shares are pledged, selling only residual rights may not qualify for capital loss claims.

4. Courts will look at the substance of transactions, not just their form.

Issue: 

The main question here is: Can a company claim a long-term capital loss on the sale of shares that belonged to a company in liquidation, when those shares were already pledged to a bank?

Facts: 

- Bijal Investment Co. (P) Ltd. is our protagonist here.

- They had 27,410 shares of Rustom Mills and Industries Ltd. (RMIL).

- These shares were pledged with IDBI Bank.

- RMIL had gone into liquidation.

- Bijal sold these shares to a sister company and claimed a long-term capital loss of Rs.19,61,617.

- This happened during the assessment year 1994-1995.

- The Income Tax Officer said, "Hold up, that's not a valid transfer!"

- The case bounced around from the Assessing Officer to the CIT (Appeals) to the Tribunal, and finally landed in the High Court.

Arguments:

Bijal's side was like, "Hey, shares are movable property! We can transfer them with a deed of assignment. It's totally valid, and we should get that capital loss!"

The tax folks weren't having it. They said, "Nuh-uh! The company was in liquidation, and you didn't get permission from the court. That transfer is as good as void!"

Key Legal Precedents:

1. Assistant Commissioner of Income Tax vs. Biraj Investment (P) Ltd. [2012] taxmann.com 273 (Gujarat): This case said that for income tax purposes, a transfer can be complete even if the shares are pledged. But the court here said, "That's different from our situation."

2. A.M.P. Arunachalam vs. A.R. Krishnamurthy: Another case about pledged shares, but the court said it doesn't apply here because in that case, the buyer was willing to pay off the entire pledge.

3. Sunil Siddharthabhai vs. CIT (156 ITR 509): This one's about how if the tax law doesn't have a way to calculate something, it's outside the scope of the law.

Judgement:

The court sided with the tax department. Here's why:

1. Section 536(2) of the Companies Act, 1956 says transfers of shares in a company under liquidation are void without court permission. Bijal didn't get that permission.

2. Even if the transfer was valid (which it wasn't), Bijal only transferred the residual rights in the pledged shares. The court said, "We can't figure out the cost of just those rights, so we can't calculate a capital loss."

3. The court basically said, "Nice try, but no dice. You can't claim a capital loss on a transfer that's not valid in the first place."

FAQs:

1. Q: Does this mean you can never sell shares of a company in liquidation?

  A: Not exactly. You can, but you need to get permission from the court overseeing the liquidation.

2. Q: What if I've already claimed a loss on a similar transaction?

  A: You might want to consult a tax professional. This judgment suggests such claims could be challenged.

3. Q: Does pledging shares always create problems for selling them?

  A: Not always, but it can complicate things. It's best to clear any pledges before selling if possible.

4. Q: How does this affect the definition of "transfer" in the Income Tax Act?

  A: It doesn't change the definition, but it shows that other laws (like the Companies Act) can affect whether a transfer is valid for tax purposes.

5. Q: Could Bijal have done anything differently to claim the loss?

  A: Potentially. They could have tried to get court permission for the transfer or settled the pledge before selling.

1. Being aggrieved and dissatisfied with the impugned judgment and order passed by the Income Tax Appellate Tribunal, Ahmedabad Bench ‘C’ (hereinafter referred to as the Tribunal) dated 28.10.2005 in ITANos. 1245/Ahd/2000 for the Assessment Years 1995­96, the assessee has preferred the present Tax Appeal for consideration of the following substantial question of law which were framed while admitting the matters:

”(I) Whether, in the facts and circumstances of the case the Income Tax Appellate Tribunal was right in law in holding that the appellant is not entitled to long term capital loss of Rs.19,61,617/­ as there is no valid transfer of the shares sold?

(ii) Whether, in the facts and circumstances of the case the income Tax Appellate Tribunal was right tin law in holding that the cost of shares which are pledge cannot be ascertained and resultantly since the machinery provisions of Section 48 fails, loss arising from such transfer has to be disallowed?

2. The facts of the case are that the appellant­assessee is a company registered under the Companies Act. During the previous year to the relevant assessment year 1994­1995, the assessee had pledged 27410 equity shares with the IDBI Bank, which had gone in liquidation when it was pledged. The assessee had shown a long term capital gain of Rs.19,61,617/­ on sale of such shares of RMIL to its sister concern. On such sale of shares, the asseess had claimed long term capital loss of Rs. 19,61,617/­.

2.1 The Assessing Officer noted that the shares of Rustom Mills and Industries Ltd. which the assessee sold were pledged with the IDBI Bank and treated the transfer of the impugned 27410 shares as not valid in the eye of law. The Assessing Officer disallowed the loss arising on the sale of the shares of RMIL( being 27410 in number) amounting to Rs. 19,61,617/­. The assessee therefore, preferred appeal before the CIT ( Appeals). The CIT (Appeals) upheld the assesse’s claim directing the allowance of the long term capital loss.

2.2 The revenue therefore carried the appeal in the Tribunal. The Tribunal has distinguished its own view and allowed the revenue’s appeal. Being aggrieved and dissatisfied with the impugned order passed by the Tribunal, the assessee has preferred the present Tax appeal for consideration of aforesaid substantial question of law.

3. Learned advocate appearing for the appellant submitted that the shares in the company are movable property and can be transferred through deed of assignment and stated that the transfer is valid and long term capital loss should be allowed to assessee company. Learned advocate appearing for the assessee relied upon the decision of this Court in case of Assistant Commissioner of income Tax versus Biraj Investment (P) Ltd. ­ [2012] taxmann.com 273( Gujarat) [2012] Taxman 418 (Gujarat) wherein it is held that the assessee, having entered the agreement with the purchaser company and further having given power of attorney and received the full sale consideration from the purchaser company, by virtue of section 2(47), for the purpose of income­tax, transfer of share was complete. It is further held that it may be that by virtue of pledging of shares with the bank having handed over the original share certificates to such financial institution along with the duly signed transfer forms, insofar as the assessee’s relation with the bank is concerned, there would be a serious question of validity of such transaction. The High Court, however, in the present proceedings, is not concerned with such internal possible dispute between the assess and the said financial institution. It may also be that if the purchaser company desired to have such shares transferred in its name, such attempt would run into serious roadblock. Primarily, without the original share certificates in possession of the purchaser company, which were in possession of the IDBI bank, the company would not in view of section 108 of the Companies Act, be able to register such transfer. Further it is held that the assessee did transfer whatever rights it had in the shares to the purchaser company. If such transfer is not recognized by the IDBI and there are other legal implications of breach of undertaking given to IDBI, such issue would have to be thrashed out between the concerned parties. It is further held that in so far as income tax proceedings are concerned, by virtue of section 2(47), the assessee was entitled to claim that upon transfer of shares or interest thereon, it had suffered long term capital loss which it was entitled to set off against the capital gain on sale of shares during the same previous years.

4. However, learned advocate for the respondent contended that Tribunal found that the facts of the present case are distinguishable from that of the case before the ITAT in the case Biraj Investments Pvt. Ltd versus Assistant Commissioner of Income Tax and also before the Hon’ble Madras High Court in case of A.M. P. Arunachalam versus A.R. Krishnamurthy and others. Section 536 sub section (2) of the Companies Act, 1956 reads as:

“(2) In the case of a winding up by or subject to the supervision of the Court, any disposition of the property (including actionable claims) of the company, and any transfer of shares in the company or alteration in the status of its members, made after the commencement of the winding up, shall, unless the Court otherwise orders, be void.

4.1 Learned advocate for the respondent therefore, contended that when the transaction itself is bad in law, the case which has been relied upon by the assessee in case of Assistant Commissioner of Income Tax versus Biraj Investment ( P) Ltd. ( supra) is not applicable to the present case.

5. We have carefully considered the submissions made by learned advocates for both the sides. It is borne out from the record that the assessee had not taken permission of the relevant statutory authority regarding sale of said shares. The assessee’s reply to the Assessing Officer remained silent on the issue of statutory permission. Section 536(2) of the Companies Act, 1956 is very clear regarding the avoidance of transfers after commencement of winding up. In the case of a winding up by or subject to the supervision of the Court, any disposition of the property (including actionable claims) of the company, and any transfer of shares in the company or alteration in the status of its members, made after the commencement of the winding up, shall unless the court otherwise orders, be void. In view of provisions of Section 536(2) of the Companies Act, 1956, any transfer of shares or alternation in the status of members of the company after commencement of winding up is void unless the High Court otherwise orders in respect of particular transactions and hence the transfer of 27410 shares of Rustom Mills and Industries Ltd. stated to have taken place on 21.3.1995 by so called deed of assignment is void and therefore, the question of capital gain of loss does not arise. Section 536(2) of the Companies Act declares the transfer of shares during the liquidation proceedings as void. The transfer of shares includes transfer of rights in shares which is declared void under Section 536(2) of the Companies Act and therefore, it is not a transfer at all and therefore, the question of capital gains/losses on the said transaction does not arise.

Therefore, the transfer of 27410 shares of M/s Rustom Mills Industries Ltd by the assseess company by way of deed of assignment is held as void and not falling under the Section 2(47) of the IT Act with no consequences as to the claim of long terms capital loss of Rs.19,61,617/­ is not allowed to the asessse.

6. Further the Tribunal has found that the assigned shares being encumbered to the extent of the liability guaranteed by the assessee company to IDBI what could be assigned, even assuming such a transfer to be valid, is the residuary rights in the said shares, which (shares) can only be considered as composite of the entire bundle of rights associated forthwith. As such, what the assessee stands transferred is such residuary rights in the impugned shares, the cost of which is not ascertainable with reference to the provision of the Income Tax Act 1961. It is held by Hon’ble Supreme Court in the case of Suni Siddharthabhai Versus­CIT ­ 156 ITR 590) that if the machinery provision (s) of law does not provide for or envisage the working in a given circumstance/situation the said transaction ought to be considered as outside the ambit of the charging provision of the said Act.Here it may also be pertinent to state that in the case of AMP Arunchalam (Supra) where the rights of the pledge of shares in a company stands discussed, the transferee, along with request for transfer of shares in its name, also sought to discharge the entire liability to the pledge in respect of which the said shares stood pledged,so that it had no surviving right in those shares, i.e. the transfer(being sought) would operate to transfer the entire property in the said shares, which in the present case, what is sought to be transferred admittedly as per the deed of assignment is only the limited/residuary rights in the pledged shares. We therefore are of the opinion that the question raised in the present appeals are required to be answered in favour of the revenue.

7. Accordingly, we answer the question raised in the present set of appeals in the affirmative i.e. in in favour of revenue and against the assessee. Tax Appeal is accordingly dismissed.

(K.S.JHAVERI, J.)

(G.R.UDHWANI, J.)