2008 (11) TMI 16 - SC - Income Tax

Whether any gift arose in terms of Section 2(xii) of the Gift-tax Act on the allotment of rights issue by the company to its shareholders - on question of evasion of tax, contention of Department is conflicting Dept. has messed up entire case - Department has not kept in mind the difference between allotment & renunciation Dept. has not invoked the provisions of Gift-tax Act against renouncer shareholder despite the observation of the CIT(A) in that regard - Assessee s appeal allowed

Summary

Issues Involved:
1. Whether any "gift" arose in terms of Section 2(xii) of the Gift-tax Act, 1958 on the allotment of rights issue by the appellant company to its shareholders.
2. Whether there was any element of "gift" as defined under Section 2(xii) in the appellant issuing Bonus shares in the ratio of 1:23 in April/May, 1986.

Issue-wise Detailed Analysis:

Issue 1: Gift Arising from Rights Issue Allotment

Background:
The appellant company allotted rights shares to seven investment companies after twenty out of twenty-seven shareholders did not subscribe to the rights issue. The Assessing Officer (A.O.) deemed this allotment as a gift under Section 4(1)(a) of the Gift-tax Act, 1958, arguing it was a colorable transaction aimed at tax evasion. The CIT(A) upheld the A.O.'s decision but suggested that the gift tax proceedings should be initiated against the renouncing shareholders, not the company. The Tribunal reversed this decision, stating that the allotment did not constitute a "transfer" of property and hence was not a gift. The High Court, however, ruled in favor of the Department, leading to this appeal.

Arguments:
- Appellant's Counsel: Argued that gift tax is not applicable on the initial allotment of shares as it does not involve the transfer of existing movable property. Cited the Supreme Court's judgment in Sri Gopal Jalan & Company v. Calcutta Stock Exchange Association Ltd., which clarified that shares come into existence only upon allotment.
- Department's Counsel: Contended that the rights issue constitutes a "deemed gift" under Section 4(1)(a) of the Gift-tax Act, as the existing shareholders have a tangible right to opt for or renounce the rights, which crystallizes into a transfer when renounced.

Supreme Court's Analysis:
The Court noted that the High Court did not consider the arguments presented. It emphasized the distinction between "creation" and "transfer" of shares, referencing Sri Gopal Jalan & Company, which held that shares are created upon allotment and do not exist prior to that. The Court found that the appellant's allotment of shares did not constitute a transfer and thus did not attract Section 4(1)(a) of the Gift-tax Act. The Court also distinguished this case from the Madras High Court's judgment in S.R. Chockalingam Chettiar, which dealt with renunciation by individual shareholders, not allotment by the company.

Conclusion:
The Supreme Court held that the allotment of rights shares did not amount to a gift under the Gift-tax Act, and the liability to pay gift tax would be on the renouncing shareholder, not the appellant company. The question was answered in favor of the appellant.

Issue 2: Gift Element in Issuing Bonus Shares

Background:
The A.O. also levied gift tax on the bonus shares issued by the appellant in the ratio of 1:23.

Supreme Court's Analysis:
The Court explained that the issuance of bonus shares is a capitalization of profits, converting surplus into capital and distributing it among shareholders. This does not involve any payment by shareholders and is intended to align nominal share capital with the excess of assets over liabilities. The Court cited its judgment in Hunsur Plywood Works Ltd. v. Commissioner of Income-tax, which supported the view that bonus shares are a capitalization of profits and not a gift.

Conclusion:
The Supreme Court concluded that issuing bonus shares does not constitute a gift as it merely represents the capitalization of profits. The shareholders are not considered donees of shares from the company. The question was answered in favor of the appellant.

Final Judgment:
The Supreme Court set aside the High Court's judgment, allowing the civil appeal filed by the assessee with no order as to costs. The Court highlighted the Department's failure to distinguish between "allotment" and "renunciation" and its conflicting stance on the nature of the alleged tax evasion.