Loss on Sale of Shares Acquired via Conversion of Debentures is Not Speculation Loss

Issue

Whether the loss incurred on the sale of shares, which were acquired by the assessee-company through the conversion of partly convertible debentures, falls under the deeming fiction of the Explanation to Section 73 (treating share trading losses as speculative), or if it constitutes a normal business loss eligible for set-off against other income.

Facts

Assessee: A company holding partly convertible debentures.
The Transaction: The debentures were converted into equity shares. Subsequently, the assessee sold these shares and incurred a loss.
The Claim: The assessee claimed this loss as a normal business loss in its return for AY 1996-97.
AO’s Action: The Assessing Officer (AO) invoked the Explanation to Section 73. This explanation provides that if a company (other than an investment or banking company) carries on the business of purchase and sale of shares, such business is deemed to be a speculation business. Consequently, the AO treated the loss as a “speculation loss,” which can only be set off against speculation profits.
Tribunal’s View: The Tribunal initially held that the activity was an organized attempt to earn profit (trading) and disallowed the set-off, treating it as speculative.

Decision

The High Court ruled decisively in favour of the assessee.
Allotment vs. Purchase: The Court distinguished between the “purchase” of shares and the “allotment” of shares.
- Purchase: Implies a transfer of existing shares from one person to another.
- Allotment (Conversion): Implies the creation/appropriation of shares from the company’s unappropriated capital. It is not a transfer.
Section 73 Applicability: The Explanation to Section 73 is triggered only when there is a “purchase and sale” of shares.
Conclusion: Since the assessee acquired the shares via allotment (conversion of debentures) and not through a “purchase” from another person, the specific condition for invoking the Explanation to Section 73 was not met.
Outcome: The loss was held to be a non-speculative business loss and was allowed to be set off against other income.

Key Takeaways

- Strict Interpretation of Deeming Fictions: The Explanation to Section 73 creates a legal fiction (deeming a business as speculative). Courts interpret such fictions strictly. If the transaction (allotment) does not fit the strict definition of “purchase,” the fiction does not apply.
- Source of Acquisition Matters: For Section 73 purposes, how the shares were acquired is crucial. Shares bought from the market trigger the provision; shares acquired via IPO allotment, conversion of bonds/debentures, or as bonus shares generally do not constitute “purchase.”

Set-Off Benefit: Normal business losses can be set off against any other head of income (except salary) in the same year, whereas speculation losses are ring-fenced and can only be set off against speculation profits.

HIGH COURT OF GUJARAT

Abhar Holdings (P.) Ltd.

Deputy Commissioner of Income-tax^*

BHARGAV D. KARIA and Pranav Trivedi, JJ.

R/TAX APPEAL NO. 2596 of 2010^†

JULY 16, 2025

Mrs. Swati Soparkar for the Appellant. Varun K.Patel for the Respondent.

ORDER

Bhargav D. Karia, J.- Heard learned advocate Mr.B.S.Soparkar through video conference for the appellant and learned advocate Mr.Dev D. Patel for learned Senior Standing Counsel Mr.Varun K. Patel for the respondent.

2. By this Appeal under Article 260A of the Income Tax Act, 1961 (for short ‘the Act’), the appellant has challenged the order dated 2nd March, 2007 passed by the Income Tax Appellate Tribunal, Ahmedabad Bench ‘A’, Ahmedabad (for short ‘the Tribunal’) in ITA No.2407/Ahd/1999/Dy. CIT v. Abhar Holdings (P.) Ltd. for Assessment Year 1996-97.

3. This Court by order dated 18.01.2012 admitted the Appeal for consideration of the following substantial question of law:

“Whether, on the facts and circumstances of the case the Hon’ble Income Tax Appellate Tribunal was justified in holding that loss on account of sale of shares amounting to Rs.37,47,304/- is speculation loss and so the same cannot be set off against the other income ?”

4. Brief facts giving rise to this Appeal can be summarised as under:

4.1. For the Assessment Year 1996-97, the appellant filed a return of income on 30.11.1996 declaring total income of Rs.54,794/- from profit and gains of business and profession and income from the other sources i.e. dividend of Rs.4,050/-.

4.2. It is the case of the appellant that during the year, the appellant had sold certain partly convertible debentures of M.H.Mills & Industries Limited and on sale of these debentures, which are converted into shares, there was a net loss of Rs.37,47,304/-which was claimed in the return of income.

4.3. The Assessing Officer, however, considered the aforesaid loss claimed by the appellant as a speculation loss by applying the provisions of Section 73 of the Act.

4.4. Being aggrieved, the appellant preferred an Appeal before the CIT (Appeals). It was contended by the appellant before the CIT (Appeals) that the shares have been received on conversion of debentures and they were standing in the name of the appellant as the appellant has purchased certain partly convertible debentures and total cost of the debentures was Rs.2.43 Crores which were sold incurring loss of Rs.37,47,304/- which was claimed as deduction.

4.5. It was also contended that no part of income of the appellant consisted of business in purchase and sale of shares and shares were actually received on conversion of partly convertible debentures which were never purchased.

4.6. It was also contended by the Appellant that it had taken actual delivery of the shares on conversion of the partly convertible debentures which were sold to reduce its losses so it cannot be considered as a speculation activity.

4.7. The CIT (Appeals) accepted the contentions of the Appellant and held that the gross total income of the Appellant would consist mainly of income which was chargeable under the head ‘Income from Other Sources’ and therefore, provisions of Explanation to Section 73 of the Act would not be attracted and hence, the sale of shares cannot be considered as speculation in nature.

4.8. The respondent-Revenue, being aggrieved by the order passed by the CIT (Appeals), preferred the Appeal before the Tribunal raising the only contention that the loss of Rs.37,47,304/- should be treated as a speculation loss and should not be allowed to be set off against the total income.

4.9. The Tribunal, after considering the submissions made by both the sides, rejected the contention of the Appellant following the Special Bench Tribunal decision in case of AMP Spinning and Weaving Mills (P.) Limited v. ITO (2006) 100 ITD 132 (Ahd) (SB) and held the issue against the appellant to the effect that the appellant had entered into the organised activity to earn profit and therefore, the loss being business loss and ultimately holding that loss incurred was a part of the share trading business and disallowed the same.

5.1. Learned advocate Mr.B.S.Soparkar for the appellant submitted that the decision relied upon by the Tribunal in case of AMP Spinning and Weaving Mills (P.) Limited (supra) has been reversed by this Court in case of AMP Spinning & Weaving Mills (P.) Ltd. v. ITO (Gujarat) and therefore, the issue is squarely covered in favour of the appellant.

5.2. It was submitted that in view of the above, it is not required to go into the second contention of the appellant, which is also rejected by the Tribunal to the effect that the main income of the appellant was income from other sources and not the business income being the interest income.

6. On the other hand, learned advocate Mr.Dev Patel for the respondent-Assessing Officer could not controvert the submissions of learned advocate Mr.B.S.Soparkar to the effect that the decision relied upon by the Tribunal in case of AMP Spinning and Weaving Mills (P.) Limited (supra) has been reversed by this Court.

7. Considering the submissions made by both the sides, it would be germane to refer to the provisions of Section 73(1) of the Act as relied by the Assessing Officer to consider the loss claimed by the petitioner as speculation loss, which read as under :

“73 (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.

Explanation – “Where any part of the business of a company (other than a company whose gross total income consists mainly of income which is chargeable under the heads “interest on securities”, “Income from House property” Capital gains” and “Income from other sources” or a company the principal business of which is 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.”

8. As per the Explanation to Section 73(1) of the Act, where any part of the business of the company other than a company whose gross total income consists mainly of income which is chargeable under the heads ‘interest on securities’, ‘income from house property’, ‘capital gains’ and ‘income from other sources’ or where principal business of a company is banking or granting loans and advances consists in purchase and sale of shares of other companies, such companies for the purpose of Section 73(1) will deem to be carrying on a speculation business.

9. Applying the Explanation to the facts of the case, the question would arise as to whether the sale of the shares by the appellant would also include the purchase and sale of the shares of the other companies or not, as the petitioner never purchased the shares which were sold during the year consideration, as the same were converted on acquisition by the appellant by acquiring the partly convertible debentures. Therefore, there was no purchase and sale activity of the petitioner so as to apply the provisions of Section 73(1) of the Act as per Explanation.

Therefore, the other question, as to whether the appellant would fall within the exception provided in the Explanation as a company whose gross total income consists mainly of income, which is chargeable under the heads other than the business income, is only to be considered for application of the Explanation to Section 73(1) of the Act.

10. This Court in case of AMP Spinning and Weaving Mills (P.) Limited (supra)) while considering the applicability of Section 73 of the Act in respect to the allotment of the shares in Public Issue for the Assessment Year 2001 to reverse the decision of the Tribunal, held as under :

“5. Having heard learned advocates for the parties and having gone through the materials on record, it is an admitted position that the Special Bench of the Tribunal was constituted to decide the following question:

Whether on the facts and in the circumstances of the case, loss arising from sale of shares applied for by a dealer and allotted to it in Public Issue is hit by Explanation to Section 73 of the Income-tax Act 1961?

5.1 The Tribunal while deciding the said question has held that even the acquisition of shares by allotment on application in Public Issue and their eventual sale will be speculation business. Section 73 of the Income Tax Act, 1961 deals with carry forward and set off losses from speculation business.

Explanation to Section 73 is a deeming provision wherein if specified conditions are satisfied, purchase and sale of shares are deemed speculation activities. This explanation becomes very important now-a-days in view of more and more NBFC activities. In this context it shall be relevant to go through Section 73 of the Act and the Explanation thereto and the same reads as under:

“73. 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 to Section 73 reads as under:

Where any part of the business of a Company [(other than a company whose gross total income consists mainly of income which is chargeable under the heads” Interest on Securities”, ” Income from House Property”, “Capital Gains” and ” Income from other sources” or a Company the principal business of which is the business of banking or the granting of Loans & Advances) consists in the purchase and sale of shares of other companies, such company shall, for the purpose 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]”.

5.2 In this regard, it shall also be useful to reproduce relevant paragraphs of the decision in the case of Khoday Distilleries Ltd. (supra) which read as under:

“5. Shri Soli J. Sorabjee, learned senior counsel appearing on behalf of the appellant, submitted that gift tax is not attracted on initial allotment of shares because there is no transfer of any existing movable property, namely, the shares. According to the learned counsel, till allotment is made, shares did not exist. It is only on allotment that shares come into existence. In this connection, learned counsel placed reliance on the judgment of this Court in the case of Sri Gopal Jalan & Company v. Calcutta Stock Exchange Association Ltd. Reported in 1964 (3) SCR 698. He also relied upon the judgment of this Court in the case of Sangramsinh P. Gaekwad and ors. V. Shantadevi P. Gaekwad (Dead) through LRs. and ors. reported in (2005) 11 SCC 314. Learned counsel further submitted that there is a vital difference between tax planning and tax evasion. According to the learned counsel, it is perfectly legitimate and permissible for an assessee to so arrange his affairs with a view to reduce its tax liability and such tax planning cannot be equated with tax evasion. In this connection, learned counsel submitted that the transaction in question was not sham or fictitious but real and it was given effect to. Moreover, it was contended that the stand taken by the Department, in this case, was conflicting inasmuch as according to the A.O. what was intended to be evaded was income-tax by the Directors of the appellantcompany whereas, according to the CIT(A), the exercise undertaken by the appellant-company was to evade wealth tax. Learned counsel submitted in the alternative that even assuming whilst denying that there was an intention to evade income tax or wealth tax, the correct course open to the Department was to include the income or wealth in the income tax or wealth tax assessment of the concerned assessee. For the aforestated reasons, learned counsel submitted that the High Court should not have interfered with the decision of the Tribunal.

7. At the outset, we may state that none of the above arguments have been considered by the High Court in its impugned judgment. In the case of Sri Gopal Jalan & Company (supra) a question arose as to the meaning of the word “allotment”. It was held that in Company Law the word “allotment” means appropriation out of previously unappropriated capital of a company, of a certain number of shares, to a person and till such allotment, the shares do not exist as such. It is only on allotment that the shares come into existence and in every case the words “allotment of shares” have been used to indicate the creation of shares by appropriation out of the unappropriated share capital to a particular person.

8. In our view, the judgment of this Court in Sri Gopal Jalan & Company (supra) squarely applies to the present case. There is a vital difference between “creation” and “transfer” of shares. As stated hereinabove, the words “allotment of shares” have been used to indicate the creation of shares by appropriation out of the unappropriated share capital to a particular person. A share is a chose in action. A chose in action implies existence of some person entitled to the rights in action in contradistinction from rights in possession. There is a difference between issue of a share to a subscriber and the purchase of a share from an existing shareholder. The first case is that of creation whereas the second case is that of transfer of chose in action. In this case, when twenty shareholders did not subscribe to the rights issue, the appellant allotted them to the seven investment companies, such allotment was not transfer. In the circumstances, Section 4 (1)(a) was not applicable as held by the Tribunal.”

5.3 Thus, from the above decision it is clear that allotment of shares by way of application in Public Issue has been held by the Apex Court under the Gift Tax Act which is a direct tax not amounting to be a transaction. Thus, the Apex Court has held that the same shall not amount to be purchase. The Tribunal has wrongly relied upon the decision of the Apex Court in the case of T.N. Arvinda Reddy (supra) which has nothing to do with the point at issue. As held in the decision in the case of Khoday Distilleries (supra) there is a vital difference between “creation” and “transfer” of shares. As stated hereinabove, the words “allotment of shares” have been used to indicate the creation of shares by appropriation out of the unappropriated share capital to a particular person. We are of the view that whichever rule of interpretation is followed, whether literal or object wise or purposive, the transactions of the assessee cannot imaginably be deemed to be a speculative business. Therefore the first question in Tax Appeal No. 957 of 2006 is answered in favour of assessee and against the revenue.”

11. In view of the above decision, where the decision relied upon by the Tribunal is reversed, the same would be applicable in the facts of the present case also because the petitioner has received the shares on the conversion of partly convertible debentures by allotment of the shares therefore, the question as to whether the shares are allotted in the Public Issue or the same are allotted on conversion of the partly convertible debentures would not make any difference as the petitioner has not purchased any shares of the other Company and therefore, the Explanation to Section 73(1) of the Act shall not be applicable in the facts of the case in view of the aforesaid decision of this Court wherein, the this Court has considered the aspect of the difference between the creation and transfer of shares.

12. In the facts of the case, on conversion of the partly convertible debentures, the shares were allotted to the petitioner by the Company from its own capital by ‘creation’ of the shares and not from ‘transfer’ of the shares from any other person. Therefore, the Explanation to Section 73(1) of the Act cannot be applied to the facts of the case.

13. In view of above, the other question as to whether the income earned by the petitioner is business income or income from other sources need not be required to be gone into.

14. In view of foregoing reasons, we are of the opinion that the Tribunal was not justified in holding that the loss on account of sale of shares amounting to Rs.37,47,304/-is speculation loss and the same cannot be set off against the other income. We therefore, answer the question in negative, i.e. in favour of the assessee and against the Revenue.

15. The Appeal is accordingly allowed. No orders as to cost.