An interesting question arises where a shareholder who is entitled to rights in equity shares transfers his rights. As a result of the rights being issued by a company, there would be a corresponding drop in the market value of the existing shares. Courts have been faced with the question whether such capital loss can be claimed as a deduction.
This point arose in CIT v New Ambadi Investments P Ltd (304 ITR 211). The facts in this case were that the assessee, under the head ?capital gains?, claimed short-term capital loss to the tune of Rs 22,42,053 in respect of sale of 43,535 rights to partly convertible debentures of EID Parry (I) Ltd at the value of Rs 5 to Tichai Investments Pvt Ltd.
According to EID Parry (I) Ltd?s rights offer, for every 10 shares held, 5 PCDs of Rs 150 were to be issued. This would be converted into one equity share of Rs 10 each, plus Rs 60 premium and balance would be the non-convertible debentures. In view of the 1:2 ratio for every right, the corresponding drop in the market value of the existing share was Rs 28.25 x 2 = 56.50. The assessee claimed the short-term capital loss of Rs 22,42,053 for the transaction on the ground that the resultant fall in the market value of the existing shares should be deducted from the amounts received, relying on the decision of the apex court in the case of DhunDadabhoyKapadia v CIT (63 ITR 651). The assessing officer held that the decision of the apex court in the case of DhunDadabhoyKapadia (63 ITR 651) would not apply to the facts of the present case, as in his opinion an asset in the form of rights must have a positive value.
However, he applied the judgment of the apex court to the extent of not computing any capital gain at all. The commissioner of income tax (appeals) held that the market value of the rights issue has to be reckoned with regardless of whether the sale contribution of the rights is less than the notional loss or not. On appeal at the instance of the revenue, the order of the commissioner (appeals) was confirmed by the appellate tribunal, holding that the decision of the apex court is squarely applicable.
In the case before the apex court in DhunDadabhoyKapadia, the assessee, who was holding by way of investment 710 ordinary shares, renounced her right to all the shares and realised certain amount. When that amount was sought to be wholly taxed as a capital gain, the assessee claimed that since the market value of the old shares fell, resulting in a capital loss, she was entitled to set it off against the capital gain realised by her. Thus, the capital gains should be computed after deducting from that amount the value of the embedded right, which became liquidated.
The apex court held that the assessee was entitled to deduct from the capital gains realised, the loss suffered by way of depreciation in the old shares, because to compute the capital gain or loss, the principles that have to be applied are those which are a part of the commercial practice or which an ordinary man of business would resort to when making computation for his business purposes.
Applying the ratio laid down by the apex court in the case of DhunDadabhoyKapadia , a Division Bench of the Bombay High Court in CIT v Motichand Construction Co P Ltd (261 ITR 70), held that the balance-sheet, profit and loss account and the computation tendered by the assessee before the assessing officer indicated that the old shares held as stock-in-trade were valued at cost and not at market price. Thus, the tribunal was right in allowing the loss.
In view of the decision of the apex court in DhunDadabhoyKapadia and the decision of the Bombay High Court in Motichand Construction Co P Ltd, the Madras High Court found that the law is well-settled on the point. Therefore, the court held that the assessee is entitled to claim the capital loss that had arisen due to transfer of rights issues.
Under section 55(2)(aa), where an assessee becomes entitled to subscribe to any share or security or is allotted any additional financial asset without incurring any cost on the basis of his existing holding of a financial asset (original financial asset), the cost is to be computed as set out below.
In a case where, by virtue of holding a capital asset, being a share, or any other security within the meaning of section 2(h) of the Securities Contracts (Regulation) Act, 1956, the assessee –
(A) Becomes entitled to subscribe to any additional financial asset; or
(B) Is allotted any additional financial asset without any payment,
Then, –
(i) In relation to the original financial asset, on the basis of which the assessee becomes entitled to any additional financial asset, cost means the amount actually paid for acquiring the original financial asset;
(ii) In relation to any right to renounce the said entitlement to subscribe to the financial asset, when such right is renounced by the assessee in favour of any person, cost shall be taken to be nil in the case of such assessee;
(iii) In relation to the financial asset, to which the assessee has subscribed on the basis of the said entitlement, cost means the amount actually paid by him for acquiring such asset;
(iiia) In relation to the financial asset allotted to the assessee without any payment and on the basis of holding of any other financial asset, cost shall be taken to be nil in the case of such assessee; and
(iv) In relation to any financial asset purchased by any person in whose favour the right to subscribe to such asset has been renounced, cost means the aggregate of the amount of the purchase price paid by him to the person renouncing such right and the amount paid by him to the company or institution, as the case may be, for acquiring such financial asset.
The assessee will continue to have the option of substituting the fair market value as on April 1, 1981 (Section 55(2)(b)) in place of the cost of acquisition as determined in terms of section 55(2)(a).
The author is advocate, Supreme Court