COMMISSIONER OF INCOME TAX Vs. L N DALMIA

JUDGEMENT

(1.) In this reference under Section 256(2) of the Income-tax Act, 1961, for the assessment year 1970-71, the following questions of law have been referred to this court :

(2.) The relevant facts are that Messrs. Punalur Paper Mills Ltd. (in short, "PPM") has a paper mill situated in the State of Kerala. Punalur Paper Mills Ltd. was under the control and management of a firm called A and F Harvey Ltd., and its other associate concerns which held the majority shares of Punalur Paper Mills Ltd. Continuous loss was suffered by Punalur Paper Mills Ltd. since a number of years and no dividend was declared by it from the years 1964 to 1968. The issued, subscribed and paid-up capital of Punalur Paper Mills Ltd. was Rs. 25,09,000 divided into 1,00,360 shares of Rs. 25 each. Out of the said shares, Messrs. A and F Harvey Ltd. and its two other associate companies, namely, Pandyan Insurance Co. Ltd. and Madurai Mills Ltd., held 51,656, 10,651 and 16,511 shares, respectively, all totalling to 78,818 shares. In October, 1967, the assessee entered into an agreement with the said Messrs. A and F Harvey Ltd. and its associates to purchase the said shares at Rs. 32 per share. The assessee on November 7, 1967, his nephew, Madav Goenka, on September 9, 1968, and his wife along with others on March 31, 1969, were appointed directors of Punalur Paper Mills Ltd. The assessee thus obtained complete control of Punalur Paper Mills Ltd. by the end of March, 1969. The break-up value of the said shares was Rs. 56.45 at the time when the assessee had purchased the said controlling interest in shares of Punalur Paper Mills Ltd. at Rs. 32 per share. The assessee had also entered into an arrangement with one Hari Prasad Lohia for sale of 40,000 shares at Rs. 50 per share out of the lot purchased by him and for sharing the control and management of Punalur Paper Mills Ltd. The agreement with the said Hari Prasad Lohia was entered into by the assessee purportedly for paucity of funds. The said agreement for sale of the shares at Rs. 50 did not, however, materialise as the said party backed out of the transaction in view of the proposed abolition of the managing agency system by the Government. The assessee did not have sufficient funds of his own and had borrowed monies for acquiring the said shares. In respect of such borrowing during the relevant previous year, the assessee had paid interest of Rs. 1,46,501.

(3.) The assessee decided to float a private limited company called Laxminiwas and Co. (Export) Pvt. Ltd. (in short, "LNE"). The assessee and his nephew were the subscribers to the memorandum and articles of association of Laxminiwas and Co. (Export) Pvt. Ltd. The printed memorandum and articles duly signed by them were deposited on March 12, 1969, with the Registrar of Companies along with the other requisite statutory documents and fees. The certificate of incorporation of Laxminiwas and Co. (Export) Pvt. Ltd. was issued by the Registrar of Companies on June 6, 1969. The assessee sold 27,162 shares of Punalur Paper Mills Ltd. to Laxminiwas and Co. (Export) Pvt. Ltd. (a company till then not incorporated) at Rs. 25 per share in May, 1969. Laxminiwas and Co. (Export) Pvt. Ltd., on June 7, 1969, after its incorporation, duly ratified the purchase of the said shares. Thereafter, a further lot of 12,000 shares of Punalur Paper Mills Ltd. was sold by the assessee to Laxminiwas and Co. (Export) Pvt. Ltd. at Rs. 25 per share. The assessee suffered a loss at Rs. 7 per share on the sale of the said 39,162 shares to the Laxminiwas and Co. (Export) Pvt. Ltd.