Section 56(viib): Tax on Issue of Shares at more than Fair Market Value

CA Rajender Handa

Clause (viib) of sub section (2) of section 56 was inserted vide finance act, 2013 w.e.f 01.04.2013 i.e. for A. Y. 2013-14 to provide that where a closely held company issues its shares at a price which is more than its fair market value then the amount received in excess of fair market value of shares will be charged to tax in the hand of the company as income from other sources. This amendment was made keeping in view the practice of closely held companies to brought in undisclosed money of promoters/directors by issuing shares at high premium which is normally over and above the book value of share of the company, and moreover which escaped the provisions of section 68. Moreover in case of many closely held companies and even in new companies promoters used to issue share at premium with the main purpose of keeping share capital low, yet capital base stronger so that breakup value and market value is high. This leads to advantage of low cost of servicing share capital and also improved prospects to issue share at premium in future by way of initial issue of offering by promoters. One more practical advantage was to save on account of cost of fees payable on increase of authorized capital. When shares are issued at premium, number of shares and authorized capital increase lesser in comparison of capital raised by way of capital and premium.

These provisions are deeming provisions as otherwise share premium and capital is a capital receipt which cannot be taxed as income. However w.e.f A. Y. 2013-14 for closely held companies share premium or share capital is deemed to be normal income if shares are issued exceeding fair market value of shares.

Clause (viib) is read as under:-

“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];

Explanation to clause (23FB) of section 10

For the purposes of this clause,-

(a) “venture capital company” means a company which-

• has been granted a certificate of registration, before the 21st day of May, 2012, as a Venture Capital Fund and is regulated under the Securities and Exchange Board of India (Venture Capital Funds) Regulations, 1996 (hereinafter referred to as the Venture Capital Funds Regulations) made under the Securities and Exchange Board of India Act, 1992 (15 of 1992); or

(B) has been granted a certificate of registration as Venture Capital Fund as a sub-category of Category I Alternative Investment Fund and is regulated under the Securities and Exchange Board of India (Alternative Investment Funds) Regulations, 2012 (hereinafter referred to as the Alternative Investment Funds Regulations) made under the Securities and Exchange Board of India Act, 1992 (15 of 1992), and which fulfils the following conditions, namely:-

(i) it is not listed on a recognised stock exchange;

(ii) it has invested not less than two-thirds of its investible funds in unlisted equity shares or equity linked instruments of venture capital undertaking; and

(iii) it has not invested in any venture capital undertaking in which its director or a substantial shareholder (being a beneficial owner of equity shares exceeding ten per cent of its equity share capital) holds, either individually or collectively, equity shares in excess of fifteen per cent of the paid-up equity share capital of such venture capital undertaking;

(b) “venture capital fund” means a fund-

(A) operating under a trust deed registered under the provisions of the Registration Act, 1908 (16 of 1908), which-

(I) has been granted a certificate of registration, before the 21st day of May, 2012, as a Venture Capital Fund and is regulated under the Venture Capital Funds Regulations; or

(II) has been granted a certificate of registration as Venture Capital Fund as a sub-category of Category I Alternative Investment Fund under the Alternative Investment Funds Regulations and which fulfils the following conditions, namely:-

(i) it has invested not less than two-thirds of its investible funds in unlisted equity shares or equity linked instruments of venture capital undertaking;

(ii) it has not invested in any venture capital undertaking in which its trustee or the settler holds, either individually or collectively, equity shares in excess of fifteen per cent of the paid-up equity share capital of such venture capital undertaking; and

(iii) the units, if any, issued by it are not listed in any recognised stock exchange; or

(B) operating as a venture capital scheme made by the Unit Trust of India established under the Unit Trust of India Act, 1963 (52 of 1963);

(c) “venture capital undertaking” means-

(i) a venture capital undertaking as defined in clause (n) of regulation 2 of the Venture Capital Funds Regulations; or

(ii) a venture capital undertaking as defined in clause (aa) of sub-regulation (1) of regulation 2 of the Alternative Investment Funds Regulations]

Applicability of This Provision

This clause is applicable when

• Shares are issued by a Closely held company;
• Amount is received from a Resident Only
• Issue price is in excess of Fair market value of shares

Valuation of Fair Market Value

Fair market value of shares is higher of the following

• Fair market value of shares calculated in accordance with Rule 11UA of the Income Tax Rules, 1962. Taking care of definitions as provided in rule 11U of the Income Tax Rules, 1962.

• As substantiated by the company to the satisfaction of 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.

So in my opinion while making calculation of fair market value as per clause (ii) of above explanation, consideration will be given to the fair market value of all assets of the company including its intangible assets. However as per rule 11UA valuation of fair market value is made at book value of assets of the company, except in the case of discounted cash flows method.

Non applicability of this Provision

This provision is not applicable on following

• Issue of shares by widely held companies like public companies having large no. of shareholder in public is interested.
• Receipt of share application money from Non Resident applicants.
• Issue price exceeding fair market value of shares but not exceeding face value of shares.
• Consideration for issue of shares is received by a venture capital undertaking from a venture capital company or a venture capital fund.
• Consideration for issue of shares is received by a company from a class or classes of persons as may be notified by the Central Government in this behalf, till date no such person are notified by the central government.