1. This is an appeal by the revenue. The assessee claimed a sum of Rs. 10,86,300 as short-term capital loss on sale of 12,070 shares of P.G.Textile Mills Ltd., Baroda. The shares had been purchased on 28-4-1976 and 27-9-1976 at Rs. 100 per share and sold to Shri N.L. Rungta, Palace Orchards, Bangalore, and Rajesh Engineering Co. (P.) Ltd., Old Madras Road, Bangalore, at the rate of Rs. 10 per share. Thus, the purchase value was Rs. 12,07,000 and the sale value Rs. 1,20,700 resulting in a claim of loss of Rs. 10,86.300. The particulars of sale are as follows:(i) N.L. Rungta, Palace 13-4-1976 5,000 shares for Rs. 50,000 Orchards, Bangalore 5-5-1977 4,000 shares for Rs. 40,000 90,000(ii) Rajesh Engg. Co. (P.) 25-8-1977 3,070 shares for Rs. 30,700 Ltd., Old Madras The ITO noticed that as per Clause III(B)(4) of the memorandum of association, one of the objects of the company was to deal in shares.
By letter dated 3-7-1979, he proposed to treat the loss as a speculation loss within the meaning of Explanation to Section 73 of the Income-tax Act, 1961 ('the Act').
(a) The company's business is in manufacture of aluminium rods and this is the first time the company purchased the shares since its inception.
(b) The said amount has been shown under the head 'Investment' in the balance sheet and not under current assets as stock-in-trade.
(c) The company has not dealt in shares at any time previously or subsequently.
(d) The purchase of shares (made as per the resolutions passed at the board meetings held on 9-4-1975 and 3-4-1976) was an investment.
(e) In view of the declining value of the shares the board of directors decided to dispose of the shares.
(f) The market value at the time of sale was nil and by selling at Rs. 10 the company was able to salvage at least Rs. 1,20,700.
(g) The Explanation to Section 73 will be attracted only where any part of the business of the company consists in purchase and sale of shares.
(h) The object clause is not a decisive factor. As the shares were held only as investment, the loss on sale thereof is a capital loss and being short term the assessee is entitled for the set off of the same against its other incomes.
(i) The company's representative in letter dated 29-10-1979 has also cited a number of decisions and pleaded that the question whether the investment should be treated as stock-in-trade or capital asset will depend on the intention of the purchaser.
The ITO did not accept the submissions made by the assessee for the following reasons: (i) As per the memorandum one of the objects is to purchase and sell shares. Hence, the transaction in question will constitute a business transaction. Merely because the amount is shown under 'Investment' in the balance sheet it cannot take away the business character of the transaction.
(ii) It was only to circumvent claims for such losses that the Explanation to Section 73 was added by the Taxation Laws (Amendment) Act, 1975.
(iii) The decisions relied on by the assessee's representative are all on cases before the introduction of the Explanation to Section (iv) As long the conditions laid down in the Exlanation are satisfied the intention at the time of purchase, the circumstances under which the distress sale took place and other factors pointed out by the assessee are immaterial.
The IAC in his directions under Section 144B of the Act has stated as follows: The fact remains that at the time of the said investment in shares the break-up value of each share was a negative figure and the cotnpany P.G. Textiles was having huge losses and was under liquidation. Hence, the purchase of shares was effected with the knowledge that there was no prospect of return on capital and it involves loss of capital. Purchase of a large quantity of commercial commodity of no value which can yield no pride of possession, which cannot be considered as investment and which cannot be turned to account except by a process of realisation is an adventure in the nature of trade (page 117 of Kanga and Palkhivala). The transaction of purchase in pith and substance was either charity or speculation and amounted to no investment as it mean in common parlance attributing prudence and caution in the investor, especiaiiy when the possession can give no pride to the owner thereof.
The Income-tax Officer was right in rejecting the contention on behalf of the assessee that the assessee had to sell the shares because the share value was declining and it was able to salvage the capital at least by accepting 10 per cent of the purchase price as sale consideration. The fact is that share price was nil at both the point of time, viz., at the time of purchase as well as at the time of sale. The loss incurred, therefore, is a speculative one. The Income-tax Officer is further right, in his observation that Explanation to Section 73 was meant to cover such transaction as one entered into by the assessee. Even if it is not a speculative loss (conceding the arguments of the assessee that it is a capital) it is speculative capital loss amounting to adventure in the nature of trade and would be covered by Section 73. Therefore, the disallowance of the loss incurred by the assessee under Explanation to Section 73 is approved. Since the transaction according to me smacks of non-genuineness the purchase of loss by the assessee was not bonafide and the same loss would have been disallowed even on the ground of non-genuineness. The Income-tax Officer in. the circumstances is justified in disallowing the loss, the addition is approved.
Accordingly, the ITO disallowed set off of the loss as speculation loss.
2. Before the Commissioner (Appeals) it was submitted that in order to invoke the Explanation to Section 73, part of the business of the company must be in purchase and sale of shares of other companies. The purchase and sale of shares of P.G. Textile Mills Ltd. was a solitary transaction and was with a view to keep it is an investment. The shares were sold off due to subsequent developments and with a view to cut down the losses. P.G. Textile Mills Ltd. had acquired the assets of another textile mills which had gone into liquidation in Court auction.
P.G. Textile Mills Ltd. wanted to modernise the plant and the assessee acquired the shares at the issue price of Rs. 100 per share only as an investment and not for the purpose of dealing.
2A. The Commissioner (Appeals) observed that the object clause in the memorandum permits the company to carry on purchase and sale of shares but that does not mean that any activity of a similar character can be construed as business. P.G. Textile Mills Ltd. was a sister-concern of the assessee. The weight of circumstances point out that the shares were acquired as an investment and not for the purposes of sale at a future date with the intention of making a profit. The sale was forced only because the investment turned out to be bad. He, accordingly, agreed with the assessee that the assessee was not a dealer in shares and the Explanation to Section 73, which permitted loss arising out of dealing in shares to be treated as speculation loss, cannot be invoked in the present case. The revenue is in appeal.
3. The learned departmental representative contended that the company, P.G. Textile Mills Ltd., had been suffering huge losses. The balance sheet as on 30-6-1976 disclosed a capital of Rs. 49.93 lakhs and accumulated loss of Rs. 52.28 lakhs. On 30-6-1977 the capital was Rs. 57 lakhs and the accumulated loss Rs. 70.92 lakhs. The position was similar prior to 30-6-1976 also. Hence, on prudent investor would purchase the shares of this company as an investment. The Commissioner,(Appeals) did not verify the facts but accepted the arguments advanced on behalf of the assessee as proved facts. The Commissioner (Appeals) did not look into the balance sheets of P.G.Textile Mills Ltd. There was nothing to indicate that the assessee was investing in shares. The circumstances indicated that the purchase of shares was a speculative venture and not an investment as the assessee was aware of the financial position of P.G. Textile Mills Ltd., right from the beginning. He submitted that the order of the Commissioner (Appeals) should be reversed.
4. Shri Jagadisan, the learned representative of the assessee, drew our attention to the memorandum and articles of association. The main objects of the company enumerated under Article III(A) related to manufacture of aluminium rods and allied businesses. Article III(C) enumerated other objects which could be undertaken with the permission of the Company Law Board. Articles III(A) and III(C) did not include dealing in shares. It is only in article III(B) that investment and dealing in shares of other companies is mentioned. Article III(B) refers to objects incidental or ancillary to the attainment of the main objects. Hence, dealing in shares was never the main object of the company and under the circumstances purchase of shares of P. G. Textile Mills Ltd., Baroda, could only be considered as an investment. He then referred to observations of the learned authors S/Shri Kanga and Palkhivala in their commentary on the Income-tax Act, pages 119 and 120, Vol. I, 7th edition. It was argued that the object, clause in the memorandum is not conclusive. The mere fact that a company is formed with trading objects in certain fields will not lead to the conclusion that all the transactions of the company are necessarily in pursuance of those objects and in the course of trade. As the directors of the assessee-company were interested in P.G. Textile Mills Ltd., the company invested in shares of P.G. Textile Mills Ltd. This was not a trading operation. He pleaded that the order of the Commissioner (Appeals) should be upheld. Losses in speculation business.--(1) Any loss, computed in respect of a speculation business carried on by the assessee, shall not be set off except against profits and gains, if any, of another speculation business.
(2) Where for any assessment year any loss computed in respect of a speculation business has not been wholly set off under Sub-section (1), so much of the loss as is not so set off or the whole loss where the assessee had no income from any other speculation business, shall, subject to the other provisions of this Chapter, be carried forward to the following assessment year, and-- (i) it shall be set off against the profits and gains, if any, of any speculation business carried on by him assessable for that assessment year; and (ii) if the loss cannot be wholly so set off, the amount of loss not so set off shall be carried forward to the following assessment year and so on.
(3) In respect of allowance on account of depreciation or capital expenditure on scientific research, the provisions of Sub-section (2) of Section 72 shall apply in relation to speculation business as they apply in relation to any other business.
(4) No loss shall be carried forward under this section for more than eight assessment years immediately succeeding the assessment year for which the loss was first computed.
Explanation: Where any part of the business of a company (other than an investment company, as defined in Clause (ii) of Section 109, or a company the principal business of which is the business of banking or the granting of loans and advances) consists in the purchase and sale of shares of other companies, such company shall, for the purposes of this section, be deemed to be carrying on a speculation business to the extent to which the business consists of the purchase and sale of such shares.
The Explanation was inserted by the Taxation Laws (Amendment) Act, 1975, with effect from 1-4-1977. This was with a view to curb attempts to reduce profits by buying losses or by similar means. The question before us is whether the purchase of shares in P.G. Textile Mills Ltd. amounts to an investment or is a speculative venture. We had the benefit of going through the balance sheets of P.G. Textile Mills Ltd. The accumulated loss on the various dates is as follows: The above figures make it plain that the mills was a heavily losing concern and no prudent investor would purchase the shares of the mills.
The assessee all along knew this fact. It is difficult for us to believe that the assessee realised that its investment was bad and, therefore, had to be got rid of at the earliest opportunity, only after purchasing the shares. The facts clearly indicate that the purchase of shares is a speculative venture. Article III(B)(4) of the memorandum of association is as follows: To invest and deal with moneys of the company in shares of other companies, debentures or debenture-stocks of other companies, Government securities, whether issued by the Central or State Governments, and in quasi-Government securities and in any such manner as may from time to time be determined." Strictly speaking, although this clause comes under 'objects incidental or ancillary to the attainment of the main objects', we fail to see how the transaction was incidental or ancillary to the main object, viz., manufacture of aluminium and other allied activities. The purchase of shares was not necessary at all in order to further the main objects of the company. Under the circumstances, we have to hold that the transaction was a speculative venture. The assessee had at no time any idea of holding on to the investment. It made use of Article III(B)(4) of the memorandum of association to enter into these transactions. The circumstances under which the shares are purchased and immediately jettisoned cannot but lead to the conclusion that the assessee indulged in speculation. It dealt with the shares not as an investment. It may not be speculation in the sense that the transactions are put through without actual delivery of the commodity but price differences are settled. The assessee acquired the shares not as an investor but as a dealer. Explanation to Section 73 will squarely apply to the facts of the case. We, accordingly, reverse the finding of the Commissioner (Appeals) in this behalf and restore that of the ITO.6 to 12. [These paras are not reproduced here as they involve minor issues.]