2007 (2) TMI 345 - AT - Income Tax

Issues Involved:
1. Classification of shares as investment or stock-in-trade.
2. Applicability of Accounting Standards.
3. Determination of loss as business loss or capital loss.
4. Treatment of conversion of investment into stock-in-trade under section 2(47)(iv) and section 45(2).

Issue-wise Detailed Analysis:

1. Classification of Shares as Investment or Stock-in-Trade:
The primary issue was whether the shares held by the assessee-company were investments or stock-in-trade. The assessee claimed that the shares were initially misclassified as investments due to an error and were actually intended to be stock-in-trade. The Assessing Officer (AO) and the Commissioner of Income Tax (Appeals) [CIT(A)] disagreed, relying on the treatment given by the assessee in its books of account, where the shares were shown as investments. The Tribunal upheld the authorities' view, noting that the shares were treated as investments in the previous year and there was no evidence to suggest an error or misclassification. The Tribunal emphasized the statutory requirements for maintaining books of account and the process through which financial statements undergo, concluding that the shares were indeed investments up to 31-3-1995.

2. Applicability of Accounting Standards:
The assessee argued that the valuation of shares should be in accordance with Accounting Standard (AS) 13 issued by the Institute of Chartered Accountants of India (ICAI), which mandates that investments should be valued at cost or market price, whichever is lower. The AO and CIT(A) noted that AS-13 was not notified by the Government, and thus not mandatory. The Tribunal agreed with this view, stating that the change in accounting policy or rectification should have been disclosed in the financial statements, which was not done by the assessee.

3. Determination of Loss as Business Loss or Capital Loss:
The assessee claimed a loss of Rs. 56,65,082 due to the reduction in the market value of shares, treating it as a business loss. The AO and CIT(A) treated this as a short-term capital loss, arguing that the conversion of shares from investment to stock-in-trade constituted a transfer under section 2(47)(iv). The Tribunal upheld this view, stating that the loss from the conversion of shares should be treated as a capital loss and not a business loss. The Tribunal noted that the shares were held as investments and the conversion to stock-in-trade was an afterthought to claim the loss as a business loss.

4. Treatment of Conversion of Investment into Stock-in-Trade under Section 2(47)(iv) and Section 45(2):
The Tribunal held that the conversion of shares from investment to stock-in-trade constituted a transfer under section 2(47)(iv). The profits or gains arising from such conversion should be computed as per section 45(2), which states that the fair market value of the asset on the date of conversion should be considered as the full value of the consideration for computing capital gains. The AO did not determine the fair market value of the shares as on the date of conversion due to the assessee's failure to provide details. The Tribunal restored the matter to the AO to ascertain the fair market value of the shares as on 1-4-1995 and compute the capital gains and business profits accordingly.

Conclusion:
The Tribunal upheld the authorities' classification of shares as investments and the treatment of the resultant loss as a capital loss. It directed the AO to determine the fair market value of the shares as on the date of conversion and compute the capital gains and business profits accordingly. The appeal was partly allowed for statistical purposes.

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