Loss On Trading In Shares Done By Directors In Individual Capacity, Cannot Be Attributed To Company: ITAT

The Bench, consisting of members Laliet Kumar (Judicial Member) and Rama Kanta Panda (Accountant Member), held that as per the Companies Act, 2013 and the Income Tax Act, 1961, the company and its directors are two distinct juristic entities, and the act done by the directors in their individual capacity cannot be said to be an act on behalf of the company.

The assessee company Nekkanti Systems Private Limited passed a Board Resolution authorizing its directors to deal in the stocks or derivatives in the stock exchange, for and on behalf of the assessee company. A sum was paid by the assessee company to its directors. Against the said sum, the directors notified the trading losses suffered by them, which was claimed as the loss of the assessee company. The Assessing Officer (AO), while computing the income of the assessee, allowed the deduction of the said trading loss and passed an assessment order. The Principal Commissioner of Income Tax (PCIT) passed an order under Section 263 of the Income Tax Act, 1961, revising the assessment order passed by the AO on the ground that the said order was erroneous and prejudicial to the interest of the revenue department. Against the order passed by the PCIT, the assessee filed an appeal before the ITAT.

The assessee Nekkanti Systems submitted before the ITAT that it is a settled principle of law that where an enquiry was conducted by the AO and thereafter, an assessment order was passed by the AO taking one of the possible views, the revisional authority cannot invoke the provisions of Section 263 to substitute its own view.

The revenue department contended that the said trading loss was caused to the directors of the assessee company while doing trading in shares in their respective D-MAT accounts.

The revenue department averred that the assessee is only entitled to debit the losses which are directly related to the activities of the assessee for carrying out its business activities. The revenue department added that the AO had erroneously allowed the debit of the trading loss caused to the directors of the assessee company.

The ITAT noted that there was no enquiry made by the AO pertaining to the claim of deduction made by the assessee for the trading loss suffered by the directors in their individual accounts. The ITAT added that for exercise of revisional jurisdiction under Section 263 of the Income tax Act, the twin conditions of an order being erroneous and prejudicial to the interest of the revenue department, should be satisfied simultaneously.

The ITAT observed that as per the decision of the Delhi High Court in ITO versus DG Housing Projects Ltd. (2012), where there is a complete lack of enquiry on the part of the Assessing Officer, the assessment order is erroneous.

Further, in view of Explanation-2 to Section 263 of the Income Tax Act, which is made effective from the assessment year 2015- 2016, w.e.f. 01.06.2015, the ITAT ruled that an assessment order is deemed to be erroneous insofar as it is prejudicial to the interest of the revenue department, if the AO fails to carry out the inquiries, which it ought to have carried out in the facts and circumstances of the case.

Despite the fact that the said trading losses were caused to the directors of the assessee company in their individual accounts, the ITAT observed the AO had allowed the said loss to be set off against the income of the assessee company without making any enquiry, which is not permissible in law. Hence, the ITAT ruled that the order passed by the AO was not sustainable.

The ITAT further noted that the Board of Directors had passed a resolution giving the directors the power to transact "for and on behalf of the company"; however, contrary to the power given by the resolution, the said directors started doing business of share trading in their individual capacity. Hence, the Tribunal ruled that the said act of the directors cannot be said to be the act of the company under the provisions of the Companies Act, 2013.

"There is distinction between the company and its directors under the Act and the act done by the directors in their individual capacity cannot be said to be an act on behalf of the company. As per the Companies Act and as well as the Income Tax Act, the company and its directors are two distinct juristic entities. Hence, both are separately assessed under the provisions of the Income Tax Act.", the ITAT said.

The Tribunal noted that the said directors and the assessee company had separate individual trading accounts and separate unique client codes, and that the said directors were trading through their individual trading accounts. The ITAT added that merely because certain sum was transferred by the assessee company to the accounts of the directors for trading in shares cannot ipso facto lead to the conclusion that the said directors were transacting for and on behalf of the assessee company.

It further observed that Section 179 (3)(e) of the Companies Act, 2013 provides that the Board of Directors of a company shall, by means of resolutions passed at the meeting of the board, invest the funds of the company on behalf of the company. The ITAT ruled that the word "invest" is required to be interpreted in a narrow sense and its meaning cannot be expanded to include "trading activities of purchase and sale of shares by the directors in their individual capacity."

Noting that the board resolution passed by the assessee company contained no reference to the said directors making any "investment" on behalf of the assessee company, as provided under Section 179(3)(e) of the Companies Act, 2013, the ITAT held that the trading of sale and purchase of shares done by the directors in their individual capacity cannot be said to be in pursuance of the resolution passed by the Board of Directors of the assessee company.

Hence, the ITAT dismissed the appeal of the assessee and ruled that the AO was not justified in allowing the deduction of the trading losses suffered by the said directors in the hands of the assessee company.

Case Title: Nekkanti Systems Private Limited versus Income Tax Officer, Ward – 16(2), Hyderabad

Dated: 27.07.2022 (ITAT Hyderabad)

Representative for the Assessee/Apellant: Mr. S. Rama Rao

Representative for the Respondent/Revenue Department: Mr. Rajendra Kumar – CIT DR

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