1. The assessee-respondent is a private limited company. It was formed in November 1971 with six brothers as shareholders. Each of the brothers had 310 shares at the time of formation of the company. The business of the company consisted of mainly export of silk sarees and textiles and manufacture of special type of yarn. During the year 1974, the company started construction of a new textile processing division at Surat which was completed by the end of 1975. It appears that in the beginning of 1975 disputes between the brothers arose. There was practically a deadlock in the management and running of the business. A family friend was asked to arbitrate amongst the brothers and settle the disputes. It was decided by the arbitrator that four brothers, viz., S/Shri Mahesh, Dilip, Kirit and Satish, should go out of the company and dispose of the shares to the family members of the other two brothers, viz., S/Shri Kishore and Anil. In turn they were to take two divisions of the company. This arrangement was effected and the four brothers mentioned above, transferred their shares in favour of the spouse and children of the other two brothers. The company was suffering losses. The assessee's accounting year is the calendar year.
The transfer of shares took place during the accounting year and in this year the company made profits and claimed set off of the previous losses.
2. The ITO disallowed losses on the ground that Section 79 of the Income-tax Act, 1961 ('the Act') applies to the facts of the case. This is what the ITO stated in his order : The face value of the share is Rs. 100 and the shares were sold to the above persons at Rs. 80 per share. The shares sold by the ex-shareholders have been purchased by the spouse and children of the remaining two shareholders. Had these shares been purchased by the remaining two shareholders, the question of applicability of Section 79 would not have arisen. But these shares have been transferred to the spouse and children of the existing shareholders with a view to avoid or reduce the tax liability of the incoming shareholders, who happen to be the spouse and children of the existing shareholders. Thus, I am satisfied that the change in the shareholding has been effected with a view to avoid or reduce the liability of incoming shareholders to tax and I disallow the set off of brought forward loss of earlier years.
3. The assessee carried the matter in appeal before the Commissioner (Appeals). He held that the IAC to whom the draft order of the assessment was sent merely directed that Clause (a) of Section 79 applies without considering whether Clause (b) would come to the aid of the assessee. Accordingly, he held that since there is no finding that the change in the shareholding was effected with a view to avoid or reduce the tax liability, the set off of losses cannot be disallowed.
The Commissioner (Appeals) also referred to the decision of the Bombay High Court in the case of Italindia Cotton Co. (P.) Ltd. v. CIT 113 ITR 58.
4. The revenue has come up in appeal before the Tribunal and the ground taken by it reads as follows : 1. On the facts and in the circumstances of the case and in law, the Commissioner (Appeals) erred in directing the ITO to allow carry forward and set off of the losses of the earlier years which claim was refused by the ITO as the case is covered by the provisions of Clause (a) of Section 79 of the Income-tax Act, 1961.
In support of this ground, the learned senior departmental representative, Shri Vohra, contended that it is for the assessee to prove that the transfer of shares was not effected for avoiding or reducing the tax liability, since the assessee is claiming set off of the loss and that onus has not been discharged by the assessee in this case. The ITO did not rest his decision only on Clause (a) of Section 79 but has also referred to Clause (b) and gave a clear finding that it would apply and as such, the assessee would not be entitled to the set off of the previous losses.
In reply the learned counsel, Shri Trivedi, at the outset objected to the consideration of Clause (b) of Section 79, inasmuch as the revenue based its case only on Section 79(a) and in view of the decision of the Bombay High Court, the assessee has to succeed in view of the clear finding of the Commissioner (Appeals), which has not been challenged.
Alternatively, he submitted that the transfer of shareholding took place under certain peculiar circumstances which were clearly brought out by the assessee before the assessing officer and which were not in dispute and as such, there was no question of avoiding or reducing the tax liability at all. On the other hand, the ITO has no material to hold that the object of the change in the shareholding was for the purpose of avoiding or reducing the tax liability. The argument proceeds further that the result may be reduction of tax liability and that is not sufficient, as the object is most relevant and such an object is absent in the facts and circumstances of the case. In this connection, he referred to the decision of the Gujarat High Court in the case of CIT v. Sakarlal Balabhai  69 ITR 186 affirmed by the Supreme Court in CIT v. Vadilal Lallubhai  86 ITR 2. He no doubt relied very strongly on the decision of the Bombay High Court on the basic question raised by the revenue about the construction of Section 5. Before dealing with the contentions, certain broad aspects have to be noticed. There is no dispute that there has been a change in the shareholding and the change is more than 51 per cent as the transfer of shares effected in this year indicates. There is thus no dispute that the assessee's case does not fall under Clause (a) of Section 79. In fact Shri Trivedi also did not argue on the basis of the exception contained in Section 79(a). His whole argument is based on Section 79(6).
6. Section 79 is a special provision relating to the set off of previous losses. The normal rule is that the losses are to be set off in respect of an assessee carrying on business. Section 79 is a sort of an exception to such a normal rule. It reads as under : Notwithstanding anything contained in this Chapter, where a change in shareholding has taken place in a previous year in the case of a company, not being a company in which the public are substantially interested, no loss incurred in any year prior to the previous year shall be carried forward and set off against the income of the previous year unless- (a) on the last day of the previous year the shares of the company carrying not less than fifty-one per cent of the voting power were beneficially held by persons who beneficially held shares of the company carrying not less than fifty-one per cent of the voting power on the last day of the year or years in which the loss was incurred; or (b) the Income-tax Officer is satisfied that the change in the shareholding was not effected with a view to avoiding or reducing any liability to tax.
The loss cannot be carried forward, if there is a change in the shareholding in the previous year in which the loss is sought to be set off unless two conditions are satisfied, viz., firstly, the change in the shareholding is less than 51 per cent and secondly, the change in the shareholding is not effected with a view of avoiding or reducing tax liability. The contention of the revenue has been that the two conditions are disjunctive and unconnected and each operates independently. This view was being canvassed and that explains why the IAC merely referred to Section 79(a) without referring to Section 79(6). In fact, this is also a ground taken by the revenue. This view of the revenue was accepted by the Tribunal. Therefore, what was being held was that if the assessee's case cannot be brought under Clause (a) of Section 79, there was no need to refer to Clause (6). However, the view taken by the Tribunal was challenged in reference in the Bombay High Court. The High Court having examined the provisions of Section 79 held that clauses (a) and (b) of Section 79 are not unconnected and Clause (b) depends on Clause (a). This was reported in Italindia Cotton (supra). The question posed for reference before the High Court was : Whether both the conditions mentioned in Clause (a) and Clause (b) of Section 79 must apply for disentitling the loss of a prior year being allowed as set-off in accordance with the substantive provisions of Section 79 of the Income-tax Act, 1961 (p. 61) This question was answered in favour of the assessee and their Lordships observed as follows : ...In our opinion, the Tribunal was in error in taking the view that the expression 'the change in the shareholding' used in Clause (b) was only referable back to the substantive provisions of the section. The Tribunal was also in error in proceeding on the footing that clauses (a) and (b) are totally disconnected and have no inter-connection between the two. In our opinion, Clause (b) will only apply to a case where the benefit of Clause (a) will not be available to an assessee and notwithstanding a change of more than 51 per cent of the voting power between the two relevant dates if a claim for set-off has to be made by the assessee, then it is for the assessee to satisfy the taxing authorities and the Tribunal that such change in the shareholding has not taken place with a view to avoiding any liability to tax if the taxing authorities and the Tribunal are so satisfied, then, notwithstanding a change of more than 51 per cent of the voting power between the two relevant dates, a claim for set-off will be permissible under Clause (b) of Section Even where a change in the voting power of more than 51 per cent on the two relevant dates has taken place, unless such change is effected with a view to avoid or reduce any liability to tax, the assessee will be entitled to the benefit of set-off under Section 79(b)... (p. 66) It is, therefore, evident that the assessee can claim the set off of the previous losses if the ITO is satisfied that the change in the shareholding was not effected with a view to reducing or avoiding the liability for tax.
7. We must first of all answer the objection raised by Shri Trivedi that the revenue is not entitled to argue on the question of Clause (b) of Section 79 in view of the ground taken in the memo of appeal. This objection is hyper-technical. In view of the contention being raised by the revenue all along that the ground was taken, but in view of the judgment of the Bombay High Court, that view is no longer valid, but, at the same time the revenue can argue that the case does not fall under Clause (b). In fact even the Bombay High Court remitted the matter to the Tribunal for considering the question of Clause (b) since that was not considered by the Tribunal in the view the Tribunal took in that case. It is essential, therefore, to look to the application of Clause (b). We also find that the ITO mentioned about Clause (b) when he observed that the change was effected with a view to reduce or avoid tax liability. It is true that the IAC did not refer to Clause (b), but then again the IAC was having the same opinion with regard to the construction of Section 79. Maybe that the IAC specifically mentioned Clause (a) but he did not mean that he disapproved what the ITO stated.
There is, thus, no substance in the objection raised by Shri Trivedi that we should not consider the applicability of Clause (b) at all, since that was not challenged in the memo of appeal. If we do that, we will be failing in our duty to give proper adjudication on the matter especially when the facts are not in dispute and there is a finding by the ITO. In fact the Commissioner (Appeals) gave a finding that there was no material before the ITO to hold that the change in the shareholding was effected to reduce or avoid tax liability.
8. Then we come to the question whether on the facts of this case, it can be stated that the change in the shareholding was effected with a view to avoid or reduce tax liability. Clause (b) of Section 79 enjoins upon the ITO to record a finding whether he is satisfied that the change was not effected with a view to avoiding or reducing the liability of tax. Unfortunately, here the ITO jumped to the conclusion that the change was effected with a view to avoiding or reducing any liability to tax on the basis of mere change in the shareholding. There is some substance in the contention of Shri Y.P. Trivedi that the ITO gave that finding abruptly, only by observing that the shares were transferred in favour of the spouse and children of the two brothers and the position would have been different if the transfer was in favour of the two brothers themselves. There is, thus, no material for coming to a conclusion that the change in the shareholding came about with a view to avoiding or reducing any liability to tax.
9. The matter can be also looked into from a different angle. The assessee gives the facts which lead to the transfer of the shares. The transfer took place by virtue of settlement of dispute amongst the brothers. The dispute was settled in a manner which was agreed to by all the parties and one of the terms of the settlement was to transfer the shares of the four brothers in favour of the family members of the other two brothers. It is, therefore, clear that the object of the change in the shareholding was for the purpose of settlement of the dispute. By no stretch of imagination, can it be stated that the object or purpose of the change of the shareholding was with a view to avoiding or reducing any liability to tax. Avoiding or reducing any liability to tax must be understood in the context of the object or the purpose of the transaction. If merely as a result there is reduction or non-payment of tax liability, it is not sufficient. The meaning to be given to the words 'avoidance of tax' occurring in Section 44F of the 1922 Act came to be considered by the Gujarat High Court in the case of Sakarlal Balabhai (supra). The head note reads as under : Avoidance of tax does not include every case of reduction of tax liability. There would be no avoidance of tax in a case where the assessee enters into a transaction which has the effect of diminishing his income and consequently reducing his tax liability.
Tax avoidance postulates that the assessee is in receipt of an amount which is really and in truth his income liable to tax but on which he avoids payment of tax by some artifice or device apparently showing the income as accruing to another person, at the same time making it available for use and enjoyment by the assessee himself.
In order to attract the applicability of Section 44F of the Income-tax Act, 1922, it is not enough that there is mere incidental escapement of tax liability as a result of the transaction entered into by the assessee. The avoidance of tax liability must be the end intended to be achieved by the assessee in entering into the transaction and must be a deliberate act. The transaction must be a concerted action directed to the end of avoidance of liability for tax. If, however, the transaction is entered into for a different purpose and is not intended to achieve avoidance of liability for tax, it would not be hit by the section even if as a result of the transaction tax liability is in fact avoided. The words 'avoidance of tax' in the marginal note of Section 44F are not colourless words but are strong and compelling words connoting a positive volition or a deliberate intention on the part of the assessee to avoid tax. The section being punitive in character must be construed strictly and if two constructions are possible one which favours taxpayer must be preferred as against the other which throws a greater burden upon him... (pp. 186-87) This decision was affirmed by the Supreme Court in Lallubhai (supra).
It is, therefore, clear from the above that while construing Clause (b) of Section 79 we must find out the object or the purpose for which the change was effected. Mere reduction of liability to tax will not disentitle the assessee to claim the set off of previous losses under Section 79. To repeat, the object for which there was a change in the shareholding was totally different and, therefore, it is not possible to hold that the change was effected with a view to avoiding or reducing any tax liability. Accordingly, the assessee clearly comes under the exception mentioned in Clause (b). The order of the Commissioner (Appeals), must, therefore, be upheld.