Preference shares Redemption not taxable as deemed dividend

Brief of the case:

• The ITAT Mumbai bench in the above cited case held that since redemption of preference shares does not result in reduction of share capital as per Sec 80 of the Companies Act,1956 , the redemption value cannot be taxed as deemed dividend as the distribution of profits if at all there may be is not resulting in reduction of capital.
• Further, the assessee did not acquire the shares free of cost but against a valuable consideration (i.e credit balance in taken over firm) , which would not result in any other  gain to assessee so as to be taxed as deemed dividend.
  

Facts of the case:

• The assessee was a partner in the firm which was converted into a company, i.e. M/s. Enviro Control Associates India P. Ltd in the books of the firm where assessee had a credit balance of  38,74,178/- as on 31.03.2001and in lieu of the said credit balance the assessee received two lakhs equity shares and 2,07,417 redeemable preference shares.
• On 18.06.2004, the said redeemable preference shares were redeemed at par Rs. 10 and the assessee received Rs. 20,74,170/-.The AO was of the view that the assessee’s receipt of the sum of Rs. 20,74,170/- on redemption of preference shares resulted in reduction of the authorized share capital and invoked the provisions of section 2(22)(d) of the Act to bring the same to tax as deemed dividend.
• On appeal to CIT(A) , he held that since no payment had been made by the assessee towards acquisition of the redeemable preference shares allotted to him, this amounted to reduction in share capital and therefore the amount of `20,74,170/- received by him on redemption thereof was deemed dividend under section 2(22)(d) of the Act.
• Aggrieved assessee is in appeal before the tribunal.

Contention of the Assessee:

• It was contended that the redemption is made out of the original amount of shares allotted to the assessee for valuable consideration and therefore there is no distribution of any profit by the company to its shareholder on redemption of preference shares.
• Further, placing reliance on the coordinate bench decision in the case of Parle Biscuits Pvt. Ltd. it was contended that by virtue of section 80(3) of the Companies Act the redemption of preference shares cannot be considered as reduction of the company’s authorized share capital and therefore redemption cannot be treated as deemed dividend as the provisions of section 2(22)(d) of the Act can be invoked only when there is a distribution of accumulated profits by way of reduction of share capital.
  

Contention of the Revenue:

It was submitted that since no payment had been made by the assessee towards acquisition of the redeemable preference shares allotted to him, this amounted to reduction in share capital and accordingly the amount received by the assessee on redemption of the redeemable preference shares amounted to receipt of dividend and the provisions of section 2(22)(d) of the Act would apply in the case on hand.

Held by ITAT Mumbai:

• The tribunal observed that the assessee received the 2,07,417 redeemable preference shares in lieu of his credit capital balance of Rs. 38,74,178/- in the erstwhile firm which got converted into M/s. Enviro Control Associates India P. Ltd.. This makes clear that the assessee was allotted the aforesaid redeemable preference for valuable consideration i.e. against the credit balance in the books of firm.

• Section 80(3) of the Companies Act, 1956 states that the redemption of preference shares cannot be considered as reduction of authorized share capital and therefore treating the same as deemed dividend under section 2(22)(d) of the Act does not arise as the same can be invoked only when there is distribution of accumulated profits by way of reduction of share capital.
• The tribunal placed reliance on its coordinate bench decision in the case of Parle Biscuits Pvt. Ltd. in ITA Nos. 5318 & 5319/Mum/2008 and 447/Mum/2009 dated 19.08.2001 wherein it was held that when there is no reduction of authorized share capital as per the provisions of section 80(3) of the Companies Act, 1956 the redemption value cannot be considered as deemed dividend as per Sec 2(22)(d). Any excess , however, of redemption value over original issue price can be taxed as capital gains.

• Following its own decision , tribunal ordered to delete the addition made by applying Sec 2(22)(d).