Case Law Details
ITO Vs Appealing Infrastructure Pvt. Ltd. (ITAT Delhi)
Material Facts
The Revenue appealed against the order of the Commissioner of Income Tax (Appeals) dated 07.12.2018 deleting an addition of ₹1,63,35,000 made by the Assessing Officer (AO) under Section 56(2)(viib) of the Income-tax Act, 1961. The assessee, engaged in construction activities, had filed its return declaring nil income. During the relevant year, it allotted 16,510 optionally convertible preference shares of face value ₹10 each at a premium of ₹990 per share to three investors. The share application money of ₹1.65 crore had been received in Financial Year 2010-11, whereas the shares were allotted during the year under consideration. The assessee submitted a valuation report dated 20.03.2015 prepared under Rule 11UA valuing the shares at ₹1,000 per share. The AO rejected the valuation on the ground that the company’s net worth was negative and treated the premium of ₹1,63,35,000 as income under Section 56(2)(viib).
Procedural History
The CIT(A) deleted the addition, holding that the consideration for the shares had been received in Financial Year 2010-11, whereas Section 56(2)(viib), effective from 01.04.2013, was not applicable to that receipt. The Revenue challenged this order before the Income Tax Appellate Tribunal.
Legal Issues
The Tribunal considered:
- Whether Section 56(2)(viib) applied in the year of allotment of shares where the share application money had been received in Financial Year 2010-11.
- Whether the Assessing Officer was entitled to reject the valuation report furnished by the assessee under Rule 11UA and adopt a different method of valuation.
Relevant Statutory Provisions
- Section 56(2)(viib) of the Income-tax Act, 1961.
- Rule 11UA of the Income-tax Rules, 1962.
- Section 42 of the Companies Act, 2013.
Parties’ Submissions
Revenue’s case
The Revenue contended that:
- The CIT(A) erred in deleting the addition of ₹1,63,35,000 made under Section 56(2)(viib).
- Section 56(2)(viib) was applicable in the year in which the shares were allotted at a premium and not in the year in which the share application money was received.
Assessee’s case
The assessee relied upon the valuation report prepared under Rule 11UA valuing the shares at ₹1,000 per share and contended that the valuation had been made in accordance with the prescribed method.
Court/Tribunal Findings and Reasoning
On the first issue, the Tribunal observed that Section 56(2)(viib) was inserted by the Finance Act, 2012 with effect from 01.04.2013. It noted that until shares are actually allotted, a subscriber may withdraw or cancel the request for allotment. The Tribunal held that the transaction becomes complete only upon allotment of shares and agreed with the coordinate bench decision that the date of share allotment, and not the date of receipt of share application money, is relevant for invoking Section 56(2)(viib).
On the second issue, the Tribunal observed that Rule 11UA(2) prescribes two methods for determining the fair market value of unquoted equity shares—the Book Value Method and the Discounted Free Cash Flow (DCF) Method—and that the choice of method is left to the assessee. It held that the Assessing Officer could reject the chosen method only after demonstrating that the methodology adopted by the assessee was incorrect or not in accordance with the prescribed standards. The Tribunal referred to the Delhi High Court’s observations in Pr. Commissioner of Income Tax Vs. M/s Cinestaan Entertainment Pvt. Ltd. that the option to choose the valuation method rests with the assessee and not with the Assessing Officer.
Considering the facts and circumstances of the case, the Tribunal held that the Revenue’s appeal was liable to be dismissed.
Final Ruling
The ITAT Delhi dismissed the Revenue’s appeal and upheld the order of the CIT(A) deleting the addition made under Section 56(2)(viib).
Cases Discussed
- Pr. Commissioner of Income Tax Vs. M/s Cinestaan Entertainment Pvt. Ltd. (Delhi High Court), ITA 1007/2019 dated 01.03.2021
FULL TEXT OF THE ORDER OF ITAT DELHI
The present appeal has been filed by the Revenue against the order of the ld. CIT(A)-I, New Delhi dated 07.12.2018.
2. Following grounds have been raised by the Revenue:
“1. Whether on the facts and in the circumstances of the case, the ld. CIT(A) has erred in deleting the addition of Rs.1,63,35,000/- made by AO on account of excessive share premium u/s 56(2)(viib) of the Income Tax Act, 1961.
2. Whether on the facts and in the circumstances of the case, the ld. CIT(A) has failed to appreciate that provisions of Section 57(2)(viib) of the Income Tax Act, 1961 are applicable in the year in which are allotted at a premium and not in the year in which the share application money was received.”
3. The assessee company is engaged in the business of construction activities. The assessee filed return of income on 26.09.2015 declaring an income of Rs. Nil. During the year, the assessee company has allotted 16,5110 optionally convertible preference shares having face value of Rs. 10/- at a premium of Rs. 990/- each to three investors. The Assessing Officer has observed that the share application money amounting to Rs.1,65,00,000/- was received by the assessee company in F.Y. 2010-11 and the shares in respect of this share application money were allotted to the investors during the year under consideration.
4. Valuation report dated 20.03.2015 prepared by the Chartered Accountant as per rule 11UA has also been filed before the AO wherein value of shares has been calculated at Rs. 1000/-. The AO has rejected the above valuations on the ground that the net worth of the appellant company was negative. The AO has treated the premium amount of Rs. 1,63,35,000/- on allotment of 16,500 preference shares as income of the appellant company u/s 56(2)(viib) of the Act.
5. The ld. CIT(A) deleted the addition holding that the assessee company received the consideration for issue of shares in F.Y. 2010-11 and the shares were allotted in F.Y. 2014-15 and hence the provisions of Section 56(2)(viib) which have come into force from 01.04.2013 cannot be applicable.
6. Aggrieved, the revenue filed appeal before us.
7. The appeal was argued on two issues,
a. Whether the provisions of Section 56(2)(viib)are applicable for the instant year while the amounts have been received in F.Y. 2010-11.
b. Whether the AO is right within his domain to reject the valuation report filed by the assessee and resort to his own method of valuation.
8. On the first issue, we have gone through the rulings of various benches. Section 56(2)(viib) has been inserted vide Finance Act, 2012 w.e.f. 01.04.2013 to provide that, where a closely held company receives in any previous year from any person being a resident, any consideration for issue of share that exceeds the face value of such shares, the aggregate consideration received for such shares as exceeds the fair market value of the shares, will be charged to tax in the hands of the recipient company as income from other sources.
9. After a subscriber entity advances amount for allotment of shares, the subscriber entity has every right to withdraw or cancel its request for allotment. Earlier, under old Companies Act regime, many companies accepted share application money under private placement and utilized the same for the business purpose even without allotment of shares. Only Schedule VI of the Old Companies Act provided the manner to treat the same in the Balance Sheet of the Company. Now, Section 42 of the Companies Act, 2013 puts prohibition over the said practice w.e.f. 1st April 2014, Companies accepting Share Application money under private placement have to allot the securities against the Share Application money received within 60 days. If the securities are not allotted within a period of 60 days, the whole application money is required to be refunded within 15 days from the date of completion of 60 days. If the company fails to repay the application money within the said 60 days period, it shall be liable to repay that money with interest @ 12% p.a. from the expiry of the 60th day. In the case of the assessee, the share application money was received in A.Y. 2011-12 and allotted in the A.Y. 2015-16. During the intervening period, the assessee had every right to get their monies refunded and opt out of the share allotment process. Hence, it would be only logical when the share allotment has been finalized, the subscriber gets allotted the shares, the provisions of Section 56(2)(viib) needs to be invoked. A taxing provision cannot be invoked even before the completion of a transaction fully and finally. We are in agreement with the judgment of the Co-ordinate Bench of Delhi ITAT in case of TS-93-ITAT-2019 (Del) had held that share allotment date, not share application, is relevant date to trigger provisions of Section 56(2)(viib).
10. With regard to the Second issue, we find that the assessee has filed a valuation report dated 20.03.2015 under Rule 11UA from an authorized valuer who valued the shares at Rs.1000/-per share as per Annexure B of the report. The valuer while determining the value of the optionally convertible preference shares as per the standards on related services (SRS) 4400.
11. The methodology used is as under:
“Present Scenario
OCPS = FV @10/- + premium @ 990/- = 1000/-
Equity = 1 Equity Share = FV @ 10/- each.
Conversion basis
1 OCPS = 100 Equity Shares
Thus, 1 OCPS, @ 1000/- = 100 Equity Shares @ 10/- per equity share.”
12. Thus, it can be found that the value of the equity shares is Rs.10/- per share after conversion.
13. Whether the AO can change the method of valuation of unquoted shares under Rule 11UA of I.T. Rules 1962?
14. The provisions of Section 56 and Rule 11UA as under: “Income from other sources.
56. (1) Income of every kind which is not to be excluded from the total income under this Act shall be chargeable to income-tax under the head “Income from other sources”, if it is not chargeable to income-tax under any of the heads specified in section 14, items A to E.
(2) In particular, and without prejudice to the generality of the provisions of sub-section (1), the following incomes, shall be chargeable to income-tax under the head “Income from other sources”, namely:—
(i) dividends;
(ia) income referred to in sub-clause (viii) of clause (24) of section 2;
(ib)…………
(viib) where a company, not being a company in which the public are substantially interested, receives, in any previous year, from any person being a resident, any consideration for issue of shares that exceeds the face value of such shares, the aggregate consideration received for such shares as exceeds the fair market value of the shares:
Provided that this clause shall not apply where the consideration for issue of shares is received—
i. by a venture capital undertaking from a venture capital company or a venture capital fund; or
ii. by a company from a class or classes of persons as may be notified by the Central Government in this behalf.
Explanation.—For the purposes of this clause,—
(a) the fair market value of the shares shall be the value—
i. as may be determined in accordance with such method as may be prescribed; or
ii. as may be substantiated by the company to the satisfaction of the Assessing Officer, based on the value, on the date of issue of shares, of its assets, including intangible assets being goodwill, know-how, patents, copyrights, trademarks, licences, franchises or any other business or commercial rights of similar nature, whichever is higher;
(b) “venture capital company”, “venture capital fund” and “venture capital undertaking” shall have the meanings respectively assigned to them in clause (a), clause (b) and clause (c) of Explanation to clause (23FB) of section 10;”
15. From the above, it is evident that the FMV of the unquoted share be the value as determined by the prescribed method or as substantiated by the assessee whichever is higher. The appellant has chosen to the first option i.e. value as per the prescribed method. The method of determining the FMV is given in Rule 11UA(2) of IT Rules 1962 which are reproduced below:
“Notwithstanding anything contained in sub-clause (b) of clause (c) of sub-rule (1), the fair market value of unquoted equity shares for the purposes of sub-clause (i) of clause (a) of Explanation to clause (viib) of subsection (2) of section 56 shall be the value, on the valuation date, of such unquoted equity shares as determined in the following manner under clause (a) or clause (b), at the option of the assessee, namely:—
(a) the fair market value of unquoted equity shares =(A-L)x (PV)/(PE) where, A = book value of the assets in the balance-sheet as reduced by any amount of tax paid as deduction or collection at source or as advance tax payment as reduced by the amount of tax claimed as refund under the Income-tax Act and any amount shown in the balance- sheet as asset including the unamortized amount of deferred expenditure which does not represent the value of any asset;
L = book value of liabilities shown in the balance-sheet, but not including the following amounts, namely:—
i. the paid-up capital in respect of equity shares;
ii. the amount set apart for payment of dividends on preference shares and equity shares where such dividends have not been declared before the date of transfer at a general body meeting of the company;
iii. reserves and surplus, by whatever name called, even if the resulting figure is negative, other than those set apart towards depreciation;
iv. any amount representing provision for taxation, other than amount of tax paid as deduction or collection at source or as advance tax payment as reduced by the amount of tax claimed as refund under the Income-tax Act, to the extent of the excess over the tax payable with reference to the book profits in accordance with the law applicable thereto;
v. any amount representing provisions made for meeting liabilities, other than ascertained liabilities;
vi. any amount representing contingent liabilities other than arrears of dividends payable in respect of cumulative preference shares;
PE = total amount of paid up equity share capital as shown in the balance- sheet;
PV = the paid up value of such equity shares; or
(b) the fair market value of the unquoted equity shares determined by a merchant banker or an accountant as per the Discounted Free Cash Flow method.”
16. From the above, it is evident that Rule 11UA(2) prescribes two methods – Book Value method and DCF method. However, the said rule also provides that the method to be adopted is left to the choice of the assessee. The AO can refuse the method of valuation after proving that the methodology resorted by the assessee is incorrect or not as per the standards laid down. The courts have held this view as is evident from the following observations of Hon’ble High Court of Delhi in Pr. Commissioner of Income Tax Vs. M/s Cinestaan Entertainment Pvt. Ltd. in ITA 1007/2019 dated 01.03.2021. The option to choose the method to be adopted to determine the FMV of unquoted shares is not with the AO but with the assessee.
17. Hence, in the peculiar facts and circumstances specific to the instant case, the appeal of the revenue is liable to be dismissed.
18. In the result, the appeal of the Revenue is dismissed.
Order Pronounced in the Open Court on 23/05/2023.
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