The Hindu Business Line : The long and short of rights

TAX treatment of capital assets when transferred depends on various factors, such as, whether the asset is movable or immovable, long term or short term, and so on. The classification of assets into long/short term is artificial. There is no uniform principle for movable/immovable properties either. Movable assets such as shares should have been held for at least 12 months to be considered as long term.

Under the present law, long-term capital gains arising from transfer of shares is exempt if it is routed through the stock exchange. For short-term capital gains, the rate is just 10 per cent. On what basis are shares classified as long term or short term? In the case of rights shares, particularly, difficulties in classification crop up.

The Jindal case

In this case (Navin Jindal vs ACIT 206 280 ITR 608 P&H), Navin Jindal held 1,500 shares in Jindal Strips Company. The company decided to issue rights shares and offered 1,875 of them at Rs 100 per share with an option of renouncement. The assessee decided to renounce the rights in favour of Colorado Trading Company at the Rs 30 per share. He realised Rs 56,250 from the renouncement.

The assessee claimed that due to issue of new rights shares, there was a sharp fall in the market value of shares already held by him. In the process, the value of his old shareholding depleted and resulted in a loss of Rs 3 lakh. He claimed this loss against the Rs 56,250 realised on account of renouncement of his rights for issue of rights shares and claimed the balance loss of Rs 2,43,750 as "short-term capital loss".

The assessing officer allowed the adjustment of loss in the value of old shareholding against the amount received on renunciation of the right to receive rights shares and accepted the assessee's contention that there was a net capital loss of Rs 2,43,750. However, he held that the loss was in the nature of long-term capital loss and not short-term capital loss as claimed by the assessee.

The controversies centred on the nature of loss, that is, whether short term or long term. The Revenue argued that the date of issue of rights was not material. The right was embedded in the old shares held by the shareholder and should be considered as having been acquired when the old shares were acquired.

The Punjab and Haryana High Court referred to the Supreme Court decision in the Dhun Dadabhoy Kapadia (1967 63 ITR 651) case, where the latter allowed the adjustment of loss on account of fall in value of old shares against the amount received on the renunciation of the right to receive rights shares on the ground that such right was embedded in the old shareholding which had matured when the decision was taken to issue the new shares.

The question whether this right was a long-term or short-term capital asset should be decided on the basis of the period for which the old shares were held. The question as to whether the gain/loss resulting from the appreciation/depreciation in the value of the original shares was long-term or short-term was not considered by the Supreme Court. This issue arose for the first time before the Punjab and Haryana High Court.Since Jindal renounced the rights without acquiring the same, the date of the right was attributed by the High Court to the date of acquisition of original shares and the adjusted loss was considered long-term capital loss.

The aforementioned Supreme Court ruling was given in 1967. It is odd that mere adjustment of profit/loss on transfer of rights shares should be taken for considering the appreciation/depreciation in the value of original shares which did not suffer transfer. This is not a case of valuation of shares as stock-in-trade. There is a need for legislative super-cession of the Supreme Court allowing such set off against the original shares.

(The author is a former Chief Commissioner of Income-Tax.)