1. Two questions have been referred to this court by the Income-tax Appellate Tribunal at the instance of the Additional Commissioner of Income-tax, Andhra Pradesh, Hyderabad. They are :
'(i) Whether, on the facts and in the circumstances of the case, the conversion of 6,000 preference shares of Hindustan Motors Ltd., into 60,000 ordinary shares amounted to 'exchange' within the meaning of Section 45 of the Income-tax Act, 1961 and
(ii) If the answer to the above question is in the negative, whether the surplus of Rs. 3,04,639 derived by the assessee on the sale of 30,000 ordinary shares of Hindustan Motors Ltd. was short-term capital gains ?'
2. The facts leading to the reference are these : The assessee, the trustees of the H.E.H. the Nizam's Second Supplement Family Trust, was assessed in the status of association of persons. For the assessment year 1963-64, the assessee submitted its return of income admitting an amount of Rs. 3,04,679 as income from long-term capital gains. The assessee purchased on September 11, 1958, 6,000 preference shares ot Rs. 100 each of Hindustan Motors Ltd. The terms and conditions attached to the issue of the said shares are such that the persons holding preference shares were given the option to convert such shares into ordinary shares on or after 1st July, 1961, but not later than 30th June, 1966, and that the preference shares are redeemable at par at any time after 30th June, 1966, at the option of the Hindustan Motors Ltd. by giving notice of three calendar months. The assessee exercised the option by converting the 6,000 preference shares into 60,000 ordinary shares of Rs. 10 each between December 14, 1961, and January 29, 1962. Out of the shares so converted, the assessee sold 30,000 ordinary shares in the months of April and May, 1962, for a sum of Rs. 6,04,679. It thus realised capital gain of Rs. 3,04,679. A claim was made before the Income-tax Officer that the said amount of Rs. 3.04,679 should be treated as long-term capital gains. The Income-tax Officer taking the date of the conversion (December 27, 1961) of preference shares into ordinary shares and the dates of their sale in April and May, 1962, held that, as the ordinary shares were not held for more than 12 months immediately before the sale, the capital gains arising from the transaction were assessable only as short-term capital gains and made the assessment accordingly. On appeal, the Appellate Assistant Commissioner was of the view that the capital gains on the exchange of the shares were liable for assessment in the assessment year 1962-63, as long-term capital gains. In coming to that conclusion, he relied upon the conversion made by the assessee on December 27, 1961, which according to him amounted to a change of the preference shares into ordinary shares and the capital gains arising thereon were liable for assessment in the year of conversion. He took the date of conversion, i.e., December 27, 1961, as the crucial date, as that date fell in the previous year of assessment 1962-63. The Appellate Assistant Commissioner held that the market value of the ordinary shares received by the assessee between December 14, 1961, and January 29, 1962, should be taken as the value of the consideration received by the assessee and that the capital gains should be calculated on that basis and when so calculated, there was short-term capital loss of Rs. 10,921 for the assessment year 1963-64. On further appeal to the Tribunal by the revenue, the Tribunal agreed with the view expressed by the lower appellate authority and held that the capital gains, which have arisen out of the exchange of the preference shares for the ordinary shares 'fall in the previous year relevant to the assessment year 1962-63' The Tribunal also agreed with the computation of the short-term loss of Rs. 10,921 made by the Appellate Assistant Commissioner for the assessment year 1963-64 and dismissed the appeal preferred by the revenue.
3. Mr. P, Rama Rao, the learned counsel appearing for the revenue, contended that conversion of preference shares into ordinary shares does not amount to an 'exchange' and that, even assuming that such conversion is an 'exchange' the computation of the capital gains on the basis of the market value is contrary to Section 45 of the Income-tax Act, 1961.
4. So, what has to be seen is whether the conversion of preference shares into ordinary shares amounts to an 'exchange'. Section 45 is in these terms:
'45. (1) Any profits or gains arising from the transfer of a capital asset effected in the previous year shall, save as otherwise provided in Sections 53 and 54, be chargeable to income-tax under the head 'capital gains' and shall be deemed to be the income of the previous year in which the transfer took place.'
5. 'Capital asset' means property of any kind held by an assessee, whether or not connected with his business or profession, but does not include what is specified in Clauses (i) to (iv) of Section 2(14). The word 'transfer' denned in Section 2(47), 'in relation to a capital asset, includesthe sale, exchange or relinquishment of the asset or the extinguishment of any rights therein or the compulsory acquisition thereof under any law'. It is an inclusive definition. The expression 'exchange' is not defined in the Act. In Black's Law Dictionary, deluxe fourth edition, at page 671, the expression 'exchange' is denned to mean 'to barter ; to swap ; to part with, give or transfer for an equivalent' It is an act of giving or taking one thing for another. The criterion in determining whether a transaction is a sale or an exchange is whether there is a determination of value of things exchanged, and if no price is set for either property it is an 'exchange' (Gruver v. Commissioner of Internal Revenue CCA 142 F 2d 363). The mutual transfers must be in kind, and any transaction into which money enters, either as the consideration or as a basis of measure is excluded. To exchange one security for a different security of some kind or for other property or rights is also an exchange. Where the holder of nearly all of a corporation's stock delivered securities to the corporation, gave the corporation his cheque in payment of preferred stock, and received from the corporation its cheque in payment of his? securities, ,and the cheques, which were simultaneously deposited, cancelled each other almost entirely, the transaction was an exchange (Louis W. Gunby Inc. v. Hehering 74 App DC 185; 122 F 2d 203).
6. In Section 118 of the Transfer of Property Act, the expression 'exchange' is defined, and it reads :
'When two persons mutually transfer the ownership of one thing for the ownership of another, neither thing or both things being money only, the transaction is called an 'exchange'. A transfer of, property in completion of an exchange can be made only in manner provided for the transfer of such property by sale.'
7. In Commissioner of Income-tax v. Motors and General Stores (P.) Ltd. : 66ITR692(SC) the Supreme Court had occasion to consider the meaning of the word 'exchange'. That was a case where the assessee-company, a private limited company, owned a cinema house at Bobbili. It was being taxed on the profits made by exhibition of films therein. At a meeting of its board of directors, it was resolved that the managing director, the Raja of Bobbili, maybe authorised to negotiate with the zamindar of Chikkayaram or his nominee, for the sale of the entire concern with all its equipment and machinery, fittings, etc., for a consideration of Rs. 1,20,000. An agreement was concluded to effect a sale and this was confirmed by the assessee-compay at an extraordinary general body meeting held on October 4, 1955. Pursuant thereto, a deed called the 'exchange deed' was brought into existence on February 21, 1956, and the consideration was received by the assessee-company; in the shape of, transfer of 5 percent, tax-free cumulative preference shares in Sri Rama Sugar and Industries Ltd., Bobbili, of the face value of Rs. 1,20,000, held by the zamindar and zamindarini of Chikkavaram. Separate valuation was given for the immovable property and for the movables, etc., and goodwill each being valued at Rs. 60,000. For the assessment year 1956-57, the assessee-company submitted a return of income showing a sum of Rs. 9,823 as profits derived from the transaction. The Income-tax Officer found that the value realised exceeded the written down value by Rs. 43,568 and accordingly computed the profits under Section 10(2)(vii) of the Indian Income-tax Act, 1922, and included the amount in the taxable income of the assessee-company. That order of the Income-tax Officer was confirmed by the Appellate Assistant Commissioner in appeal and by the Income-tax Appellate Tribunal except for allowing a sum of Rs. 5,000 as representing the cost of the goodwill. Then a reference was made under Section 66(2) to the High Court on the following two questions :
'(1) Whether the transaction dated February 21, 1956, amounts to a sale within the purview of the second proviso to Section 10(2)(vii) of the Indian Income-tax Act alternatively,
(2) Whether the consideration for the sale is not the market value of the shares as on the date of the transaction, namely, Rs. 95 per share, but the face value of the shares ?'
8. After hearing the reference, the High Court answered the question in favour of the assessee-company and against the Commissioner of Income-tax. The Supreme Court dismissed the appeal preferred by the Commissioner of Income-tax holding that the question has been rightly answered by the High Court in favour of the assessee-company. In so holding, the learned judges construed the scope of Section 118 of the Transfer of Property Act in these terms : 66ITR692(SC) :
'The definition of exchange in Section 118 of the Transfer of Property Act is not limited to immovable property but it extends also to barter of goods. It is clear, therefore, that both under the Sale of Goods Act and Transfer of Property Act, sale is a transfer of property in the goods or of the ownership in immovable property for money consideration. But in exchange there is a reciprocal transfer of interest in the immovable property, the corresponding transfer of interest in the movable property being denoted by the word 'barter'. The difference between a sale and an exchange is this, that in the former the price is paid in money, whilst in the latter it is paid in goods by way of barter.' (Chilly on Contracts, 22nd edition, volume II, page 582),
9. After referring to the operative part of the agreement, the learned judges observed:
'There is no ambiguity in the construction of the operative part. It is clear from the operative part of the document that there was an exchange of the properties described in Schedule I for 5 per cent, tax-free cumulative preference shares of Sri Rama Sugar and Industries Ltd., Bobbili. It is true that a valuation of rupees 1,20,000 was fixed to consist of Rs. 60,000 for immovable properties and the goodwill and Rs. 60.000 for movable properties but that is only for the purpose of payment of stamp duty. In essence the transaction is one of exchange and there was no sale of the properties described in Schedule I for any money consideration.'
9. The view expressed by the Supreme Court in that case leaves no room for any doubt that the conversion of 6,000 preference shares into 60,000 ordinary shares in nothing but a barter. Option was given to the persons holding preference shares to convert into ordinary shares on or after 1st July, 1961, but not later than 30th June, 1966, and they were redeemable at par at any time after 30th June, 1966, at the option of the company by giving notice of three calendar months. This is a case where there were unsubscribed ordinary shares and the company allowed exchange of such shares with the preference shares in accordance with the terms and conditions attached to the issue of preference shares. In view of the authoritative pronouncement of the Supreme Court, we hold that the conversion of preference shares into ordinary shares is a transfer by way of 'exchange' within the meaning of Section 45 of the Income-tax Act, 1961. Therefore, the first question is answered in the affirmative and in favour of the asscssee.
10. Since the first question has been answered in the affirmative, the second question docs not arise for consideration.
11. The reference is answered accordingly. The department shall pay thecosts to the assessce. Advocate's fee Rs. 250.