DEPUTY COMMISSIONER OF INCOME TAX CIRCLE-2(1)(1), BENGALURU, BENGALURU vs. ENZEN GLOBAL SOLUTIONS PVT LTD , BENGALURU

We, first, take up appeal No.696/Bang/2024 for the assessment year 2017-18

The grounds raised

We have heard both the parties and perused the material available on record. We find that this Tribunal in the assessee’s own case in and 2550/Bang/2019 vide order dated 14-09-2022 for the assessment year 2016-19 involving identical facts and circumstances has allowed the appeal of the assessee. The relevant extract of the order is reproduced below:

The next question is whether the revenue authorities can overlook the legal effect when a person holds cumulative preference shares and treat as loan instrument rather than a share capital/equity instrument. In our view the revenue authorities cannot disregard the legal effect of issue of cumulative preference shares and say that the same is akin to debt and therefore the cumulative preference shares which is a capital instrument is a debt or in the nature of debentures. A similar question arose for consideration before the Hon’ble Bombay High Court in the case of Enam Securities Pvt. Ltd. (supra). The facts of the case before the Hon’ble Bombay High Court were that the assessee in that case had subscribed to the purchase of 4 lakh preference shares each of Rs.100/- of an aggregate value of Rs.4 crores from a company by the name of Enam Finance Consultants Pvt. Ltd. in 1992. The preference shares were to carry a dividend of four percent per annum and were to be redeemable after the expiry of ten years from the date of allotment. During the course of Assessment Year 2001-02, the assessee redeemed three lakh shares at par and claimed a long-term loss of Rs. 2.73 crores after availing of the benefit of indexation. The Assessing Officer disallowed the claim of set off of long-term capital loss that arose on redemption against long term capital gain on the sale of other shares on the ground that (i) Both the assessee and the Company in which the assessee held the preference shares, were managed by the same group of 2550/Bang/2019 Page 17 of 31 persons; and (ii) There was no transfer and that the assessee was not entitled to indexation on the redemption of non-cumulative redeemable preference shares. The CIT(A) on the other hand, allowed the benefit which was claimed by the assessee. The Tribunal affirmed the view of the CIT(A) holding that the genuineness and credibility of the capital transaction was not disputed for the previous ten years. Both the Companies were juridical entities; the fact that the Companies were under common management would not indicate that the transfer was sham and that the view of the Appellate Authority was purely based on surmises and conjectures. The Tribunal has followed the judgment of the Supreme Court in Anarkali Sarabhai vs. CIT, in holding that the redemption of preference shares results in a transfer within the meaning of Section 2(47). Finally, the Tribunal has held that the noncumulative redeemable preference shares cannot be equated with debentures or bonds. According to the Tribunal, share capital issued in the form of noncumulative redeemable preference shares can never be regarded as debentures or bonds. A debenture is a loan taken by the Company. On further appeal by the revenue, the Hon’ble Bombay High Court, the Hon’ble Bombay High Court while answering Question D which reads as follows: “D. Whether on the facts and in the circumstances of the case and in law, the Tribunal is right in allowing indexation benefit on redemption of noncumulative preference shares to the Assessee Company even though such non-cumulative preference shares are in the nature of 'debt' and therefore fall into the category of bonds and debentures as envisaged by the third proviso of section 48 of the Income Tax Act." Held: “7. As regards question (D), Section 48 provides that the income chargeable under the head "capital gain" shall be computed by deducting VBC 6 itxa5372.10-27.4 from the full value of the consideration received or accruing as a result of the transfer of a capital asset: (i) The expenditure incurred wholly and exclusively in connection with such transfer; and (ii) The cost of acquisition of the asset and the cost of any improvements thereto. The second proviso to Section 48 provides for indexation where long term capital gain arises from the transfer of a long term capital asset. The third proviso, however, stipulates that nothing contained in the second proviso shall apply to long term capital gain arising from the transfer of a long term capital asset being bonds or debentures other than capital indexed bonds issued by the Government. The Assessing Officer was of the view that the principal characteristic of a bond is a fixed holding period and a fixed rate of return. According to him, the four percent non-cumulative redeemable preference shares which the assessee redeemed also had a fixed holding period and a fixed rate of return and on this basis denied the benefit of cost indexation to the assessee.

The entire basis on which the Assessing Officer denied the benefit of cost indexation was in our view flawed and was justifiably set right in the order of the Tribunal. The Income Tax Act, 1961, does not contain a definition of bonds or debentures. Both those concepts have a well settled connotation in law, particularly in the provisions of the Companies' Act, 1956. Section 2(12) of the Companies' Act, 1956 defines the expression "debenture" to include debenture stock bonds and any other securities of a company, whether constituting a charge on the assets of the company or not. Under Section 80(1) a company limited by shares may, if so authorised by its articles, issue preference shares which are, or at the option of the company are to be liable, to be redeemed. Section 85 provides that 'preference share capital' means, with reference to any company limited by shares, whether formed before or after the commencement of the Act that part of the share capital which fulfills the following requirements, namely: "(a) that as respects dividends, it carries or will carry a preferential right to be paid a fixed amount or an amount calculated at a fixed rate, which may be either free of or subject to income-tax; and (b) that as respects capital, it carries or will carry, on a winding up or repayment of capital, a preferential right to be repaid the amount of the capital paid up or deemed to have been paid up, whether or not there is a preferential right to the payment of either or both of the following amounts, namely:- (i) any money remaining unpaid, in respect of the amounts specified in clause (a), up to the date of the winding up or repayment of capital; and (ii) any fixed premium or premium on any fixed scale, specified in the memorandum or articles of the company. Explanation.- Capital shall be deemed to be preference capital, notwithstanding that it is entitled to either of both of the following rights, namely:- (i) that, as respects dividends, in addition to the preferential right to the amount specified in clause (a), it has a right to participate, whether fully or to a limited extent, with capital not entitled to the preferential right aforesaid; (ii) (ii) that, as respects capital, in addition to the preferential right to the repayment, on a winding up, of the amounts specified in clause (b); it has a right to participate, whether fully or to a limited extent, with capital not entitled to that preferential right in any surplus which may remain after the entire capital has been repaid." Section 86 provides that the share capital of a company limited by shares shall be of two kinds only namely : (i) Equity share capital; and (ii) Preference share capital.

There is fundamentally as a matter of first principle and in law a clear distinction between bonds and debentures on the one hand, and preference share capital on the other. A bond includes "any instrument whereby a person obliges himself to pay money to another on condition that the obligation shall be void if a specified act is performed, or is not performed, as the case may be". Debt securities typically are regarded as consisting of notes, debentures and bonds. Technically, a 'debenture' is an unsecured corporate obligation while a 'bond' is secured by a lien or mortgage on corporate property. However, in commercial parlance, the expression "bond" is often used indiscriminately to cover both bonds and debentures. As a matter of fact, the Companies' Act, 1956 in Section 2(12) defines 'debenture' to include debenture stock bonds and any other securities of a company, whether or not they constitute a charge on the assets of the Company. A bond is a formal document constituting the acknowledgement of a debt by an enterprise and normally contains a provision regarding repayment of principal and interest. There is a clear distinction between bonds and share capital because a bond does not represent ownership of equity capital. Bonds are in essence interest bearing instruments which represent a loan. This distinction has been accepted by the Supreme Court in R.D. Goyal vs. Reliance Industries Ltd. The Supreme Court noted that a debenture is simply an instrument of acknowledgement of debt by a company whereby it undertakes to pay the amount covered by it and till then it undertakes to pay interest to the debenture holders. The expression "share" has been defined in Section 2(46) of the Companies' Act, 1956 to mean share in the share capital of a company.

With regard to the alternate case made out by the AO by placing reliance on the provisions of Sec.14-A of the Act, we find that the assessee had contended before the CIT(A) that premium on redemption of debentures is taxable in the year of redemption and hence there was no exempt income whatsoever warranting invocation of the provisions of Sec.14-A of the Act. The CIT(A) has not addressed the issue at all. The law is clear that premium on redemption is exigible to tax under the head 'Income from Capital Gains' as laid by the Hon’ble Supreme Court in the case of Anarkali Sarabai (supra) and Karthikeya Sarabai (supra) and is not exempt from tax. Further the investment in preference shares is to be regarded as an investment in an unlisted and unquoted security and is therefore definitely exigible to tax. Section 14A comes into play only in the case of investment, income from which, is completely exempt from tax. Hence the question of any disallowance u/s 14A in respect of interest paid on loans, which are utilised to make the investment, is to be allowed as a business expenditure. If the same is claimed and allowed as a business expenditure, the same cannot be treated as part of cost of investment and be allowed for indexation while determining cost at the time of redemption of the shares. Therefore, the disallowance cannot be sustained even by application of the provisions of Sec.14-A of the Act.

For the reasons given above, we hold that the Revenue authorities were not justified in adding a sum of Rs.17,09,02,887/- being notional premium receivable on preference shares as income of the assessee. The appeal of the assessee is accordingly allowed.”

The findings given in the case cited above are applicable to the facts of the case on hand as the facts of the case are identical. Hence, respectfully following the same, we are inclined to confirm the order of the NFAC, New Delhi on the impugned issue and dismissed the Revenue appeal. Hence, ground of appeal of the Revenue is dismissed.

In the result, the appeal of the Revenue is dismissed.

The facts of the case on hand for the assessment year 2018-19 is identical to the facts of the case discussed above for the assessment year 2017-18. Therefore, respectfully following the same, we are inclined to dismiss the appeal of revenue in the light of the above stated discussion. Hence, the ground of appeal of the Revenue is dismissed.

In the result, the appeal of the Revenue is dismissed.

In the combined result, both the appeals filed by the Revenue are dismissed.