PH4 Food and Beverages Private Limited Vs DCIT (ITAT Bangalore Bench)
Convertible Tomorrow Is Not Equity Today: FCCDs Outside “Issue of Shares” u/s 56(2)(viib)—Bangalore ITAT Deletes ₹3.88-Crore Angel-Tax Addition
Summary: The Bangalore ITAT held that money received on the issue of Fully & Compulsorily Convertible Debentures (FCCDs), which were convertible into equity only in a future year, could not be taxed u/s 56(2)(viib) as excess consideration for the “issue of shares.” In the absence of any deeming provision treating unconverted FCCDs as shares, the Tribunal deleted the addition of ₹3,88,31,457.
Two Instruments, Two Different Valuations
The assessee, engaged in the food & beverages business, issued equity shares at ₹352 per share & FCCDs at ₹704 each during AY 2021-22.
An internal DCF working prepared for the equity rights issue determined the value at approximately ₹352 per share. A subsequent valuation by an IBBI-registered valuer, also under the DCF method, determined the value of FCCDs at ₹703.89.
The assessee explained that the equity issue was relatively small & undertaken during severe Covid-related financial stress to ensure immediate survival of the business. Subsidiaries that had not commenced operations were valued at their investment/book value without considering projected cash flows.
The later FCCD issue raised approximately ₹18.15 crore for investment in subsidiaries, business expansion, repayment of loans, emergency funding & completion of a brewery project. Improved economic conditions, expansion plans & expected future cash flows of subsidiaries were therefore considered in the registered valuation.
AO Adopted Earlier Equity Value
The AO noticed that the two DCF exercises, conducted about six months apart, valued the business at approximately ₹69.99 crore & ₹142.02 crore, respectively.
He rejected the explanation that changed commercial circumstances justified the difference. According to him, the assessee failed to demonstrate any accounting standard, SEBI rule or statutory principle permitting different treatment of subsidiaries in the two valuations.
The AO treated FCCDs as quasi-equity instruments based upon RBI guidelines & the FDI policy. He adopted ₹352.60 per instrument as the fair market value & compared it with the FCCD issue price of ₹704.
Since 1,10,505 FCCDs had been issued to resident investors, the difference of approximately ₹351.40 per FCCD was treated as excess premium. An addition of ₹3.88 crore was consequently made u/s 56(2)(viib).
CIT(A) Treated FCCDs as Equity
The CIT(A) relied upon the Supreme Court’s decision in IFCI Ltd. v. Sutanu Sinha. Applying the “repayment of principal” test, he held that where compulsory conversion into equity eliminates the possibility of repayment of principal, the instrument assumes the character of equity rather than debt.
He accordingly upheld the AO’s treatment of FCCDs as equity & confirmed the addition.
Charging Provision Says “Shares,” Not “Convertible Securities”
The Tribunal examined the language of s.56(2)(viib) as applicable to AY 2021-22. The provision applied where a closely held company received consideration from a resident “for issue of shares” exceeding the fair market value of such shares.
The section did not refer to securities, debentures, convertible instruments or securities capable of future conversion into shares. Rule 11UA prescribed methods for determining the FMV of shares but did not create any fiction treating FCCDs as shares before conversion.
The Tribunal held that the scope of a charging provision could not be enlarged merely because the instrument was certain to convert into shares later. The issue of an FCCD & its subsequent conversion into equity are two separate taxable events.
When consideration was received, the company issued a debenture carrying independent contractual terms—not an equity share. Certainty of future conversion did not alter the character of the instrument on the date of issue for applying s.56(2)(viib).
FCCDs Had Not Matured During the Relevant Year
The FCCDs were due to mature & convert into equity only in March 2024. During AY 2021-22, they remained debentures & carried a one-time coupon of 24%/34.33%. The interest expenditure on them had also been allowed without dispute.
The Tribunal distinguished IFCI Ltd. v. Sutanu Sinha because that ruling arose under the Insolvency & Bankruptcy Code at a stage when the CCDs had matured & become automatically convertible. Here, the instruments had not matured during the relevant previous year.
Regulatory treatment under RBI/FDI rules or the Insolvency Code could not expand the narrower charging language employed in the Income-tax Act.
Conversion & Receipt Must Coincide as Contemplated
The Tribunal relied upon DCIT v. Rankin Infrastructure (P.) Ltd., where convertible debentures issued in an earlier year were converted into preference shares later without fresh consideration. It was held that s.56(2)(viib) contemplates both receipt of consideration & issue of shares in the relevant manner.
The decision in Milk Mantra Dairy (P.) Ltd. v. DCIT was also distinguished because it concerned tax consequences at the stage of conversion. The present addition was made in the year of initial FCCD issuance, well before conversion.
To accept Revenue’s case would require reading the words “FCCDs or other securities convertible into shares” into s.56(2)(viib)—a legislative exercise impermissible while interpreting a provision taxing capital receipts.
Once the jurisdictional requirement failed, comparison between ₹704 & ₹352.60 became academic. Nevertheless, the Tribunal noted that the AO had substituted an independent registered valuation with an internal Covid-period working without identifying any specific defect in the valuer’s report or assumptions.
The addition of ₹3.88 crore was deleted & the assessee’s appeal was allowed.
Author’s Comments
The ruling draws a precise distinction between an instrument’s commercial destination & its legal character when issued. Compulsory conversion may guarantee future equity, but it does not rewrite the transaction retrospectively.
For s.56(2)(viib), statutory vocabulary controls the charge. A debenture carrying a future equity ticket cannot be taxed as though it has already boarded the share-capital train.
Cases Discussed
- IFCI Ltd. v. Sutanu Sinha & Ors. [2023 SCC OnLine SC 1529]
- DCIT v. Rankin Infrastructure (P.) Ltd. [2022] 142 taxmann.com 37
- Milk Mantra Dairy (P.) Ltd. v. DCIT [2022] 140 taxmann.com 163
- SGM Webtech Private Limited v. Boulevard Projects Private Limited, (IB) No. 967 (PB)
- Narendra Kumar Maheshwari v. Union of India, 1989 AIR SC 2138
- CIT v. Bharat Engineering and Construction Co. [1972] 83 ITR 187
- Wipro Ltd. v. DCIT [2015] 62 taxmann.com 26
FULL TEXT OF THE JUDGMENT/ORDER OF ITAT BANGALORE
This appeal is filed by the Assessee against the order of Ld. PRINCIPAL CIT(APPEALS) 11 vide DIN: ITBA/AST/S/143(3)/2022-23/1048218265(1) dated 26- Nov-2025 for the Assessment Year 2021-22.
2. The assessee, in the appeal memo, has raised multiple, detailed, interconnected grounds that pertain to a single issue, the addition made under section 56(2)(viib) of the Act, holding that the FCDD was issued at a value exceeding its fair market value.
3. The necessary facts are that the assessee, a private company, is engaged in the business of food and beverages. During A.Y. 2021-22, the assessee issued equity shares at Rs. 352 per share and Fully and Compulsorily Convertible Debentures (FCCDs) at Rs. 704 each. For the FCCDs, the assessee obtained a valuation from a registered valuer under the DCF method, determining the value at Rs. 703.89 per share. However, for the equity shares, an internal DCF valuation had determined the value at Rs. 352 per share. The AO noticed substantial variation between the two valuations made within the same financial period and proposed to tax the excess amount received on FCCDs from resident investors u/s 56(2)(viib) of the Act i.e. over and above Rs. 352 per share.
3.1 The assessee submitted that due to Covid-19, its business was adversely affected, and it incurred substantial losses. The equity shares were issued to raise immediate funds for continuing the business.
3.2 The amount raised through equity shares was relatively small. Therefore, the subsidiaries were valued at their investment/book value. These subsidiaries had not yet started operations. Hence, their projected future cash flows were not considered.
3.3 In contrast, the FCCDs were issued for a much larger amount of about Rs. 18.15 crore for investment in subsidiaries, expansion of business, repayment of loans and meeting emergency funding requirements. Therefore, the expected cash flows from the subsidiaries and expansion plans were considered while valuing the FCCDs.
3.4 The assessee further submitted that an independent registered valuer carried out the FCCD valuation under the DCF method in accordance with International Valuation Standards. The earlier valuation of Rs. 352 was merely an internal valuation made by the management for the rights issue. It was contended that the AO could not reject the DCF valuation made by an independent registered valuer, as the assessee was entitled to choose the prescribed method of valuation under Rule 11UA. The assessee also contended that FCCDs were in the nature of debt until their conversion into equity and, therefore, the provisions of section 56(2)(viib) of the Act were not applicable. It relied upon the decision of the Kolkata Tribunal in Milk Mantra Dairy Pvt. Ltd. It was also submitted that several FCCD allottees were non-residents and section 56(2)(viib) of the Act, as applicable for the year, did not apply to amounts received from non-residents.
3.5 However, the AO rejected the assessee’s explanation. He observed that both valuations were based on the DCF method and were made within a gap of about six months, yet they resulted in substantially different values. In the equity valuation, the business was valued at about Rs. 69.99 crore, whereas for the FCCDs it was valued at about Rs. 142.02 crores. According to the AO, the assessee could not establish any accounting standard, SEBI rule or statutory basis permitting such different treatment of the subsidiaries in the two valuations. The AO also questioned the projected figures, particularly when the assessee itself claimed that its business was severely affected by Covid-19 and its subsidiaries had not commenced operations. He therefore treated the FCCD valuation of Rs. 703.89 as unreliable and adopted Rs.352.60 per share based on the earlier DCF valuation as the FMV.
3.6 The AO further rejected the argument that FCCDs were merely debt instruments. Relying upon the RBI guidelines and FDI policy, he held that fully and compulsorily convertible debentures are quasi-equity instruments and are treated at par with equity. He also distinguished the decision in Milk Mantra Dairy Pvt. Ltd. on facts. Accordingly, he held that section 56(2)(viib) of the Act was applicable to the FCCDs issued to resident investors.
3.7 The AO found that 1,10,505 FCCDs had been issued to resident investors at Rs. 704 each. After adopting the FMV at Rs. 352.60, he treated the difference of about Rs. 351.40 per FCCD as excess premium. Accordingly, an addition of Rs. 3,88,31,457 was made as income from other sources u/s 56(2)(viib) of the Act.
4. The aggrieved assessee preferred an appeal before the learned CIT(A).
5. Before the learned CIT(A), the assessee submitted that the FCCDs were valued by an independent registered valuer using the DCF method. The valuation was made in conformity with the International Valuation Standards issued by the International Valuation Standards Council. The registered valuer was recognised and governed by the IBBI. The FCCDs were issued for investment in subsidiaries, expansion of the assessee’s business, repayment of loans and other funding requirements. Therefore, the valuation made by the independent registered valuer could not be rejected merely by comparing it with an earlier internal valuation made for issue of equity shares.
5.1 The assessee further submitted that section 56(2)(viib) of the Act read with Rule 11UA prescribes specific methods for determining the FMV of equity shares, including NAV and DCF methods. According to the assessee, the AO neither adopted any prescribed method nor properly questioned the DCF valuation report submitted by the independent registered valuer. The assessee also contended that FCCDs are not equity shares and their pricing cannot be subjected to the valuation provisions applicable to equity shares unless and until they are converted into shares.
5.2 Without prejudice, it was argued that FCCDs are in the nature of debt until their conversion into equity. The return on FCCDs is in the nature of interest and not dividend. FCCDs are hybrid instruments having different commercial features, risk profile and rights as compared to equity shares. Therefore, the price paid for FCCDs could not be directly compared with the price of equity shares for determining alleged excess premium u/s 56(2)(viib) of the Act.
5.3 The assessee also explained that there was a time gap of about six months between the earlier equity issue and the FCCD issue and both transactions took place in different financial and commercial circumstances. The equity shares were issued during the peak of the Covid-19 pandemic when the business was under severe operational stress and funds were required mainly for survival. In contrast, by the time FCCDs were issued, economic conditions had improved, growth visibility had increased and the assessee required larger funds for expansion and establishment of a manufacturing facility through its subsidiary.
5.4 It was further submitted that the higher FCCD valuation reflected improved business prospects, future earning potential, project pipeline and expected returns from the proposed expansion. The FCCDs also carried different commercial terms, including priority in repayment, fixed coupon return, and compulsory conversion. Therefore, the earlier equity valuation could not be mechanically applied to the subsequent FCCD issue.
5.5 The assessee also relied upon the recovery in the broader equity market and share prices of comparable companies between June 2020 and March 2021. It was pointed out that companies such as Jubilant FoodWorks Ltd. and Speciality Restaurants Ltd. had witnessed substantial appreciation in their market prices during this period. According to the assessee, this demonstrated the improvement in market conditions and supported the higher valuation adopted for the FCCD issue.
5.6 The assessee further relied upon judicial precedents of Hon’ble Supreme court in the case of CIT vs. Bharat Engineering and Construction Co. reported in [1972] 83 ITR 187 to contend that capital receipts cannot be taxed unless specifically brought within the charging provisions of the Act. Further relied on the ruling of Karnataka High court in the case of Wipro Ltd v. DCIT reported in 62 taxmann.com 26 that hybrid financial instruments must be examined according to their true character rather than merely equated with equity shares. Accordingly, it was submitted that the AO erred in adopting the earlier equity valuation as the FMV for FCCDs and in treating the difference as excess premium taxable u/s 56(2)(viib) of the Act. The assessee therefore requested deletion of the addition.
5.7 However, the learned CIT(A), after relying on the ruling of the Hon’ble Supreme Court in IFCI Ltd vs Sutanu Sinha, reported in 156 taxmann.com 681 held that FCCDs are equity and accordingly confirmed the addition made by the AO. The relevant finding of the learned CIT(A) is extracted as under:
7.10 I have perused the appellant’s submissions and observed that the FCCDs were issued for the purpose of investments in the subsidiaries, expansion of the business of the appellant, repayment of the old loans etc. FCCDs are on a different footing as compared to the equity shares.
Section 56(2)(viib) provides that:
1. where a closely held company (“CHC”);
2. receives any consideration from any person, whether resident or non- resident;
3. for the issue of shares in excess of the fair market value;
4. determined under Rule 11UA(2)
5. such excess amount shall be chargeable to tax under the head ‘Income from Other Sources’.
7.11 On reading the above, it is clear that if a closely held company receives consideration for issue of shares in excess of the FMV as determined u/s Rule 11UA(2), the excess amount is charged as Income from other sources.
7.12 Now, the next question is whether FCCDs partake the character of equity shares?
In November 2023, the Supreme Court of India (“Supreme Court”) delivered its judgment in IFCI Limited v. Sutanu Sinha (“IFCI Limited”) that dealt with the question whether CCDs are to be treated as ‘debt’ or ‘equity’ in a different context. This note analyzes the Supreme Court judgment and the ‘repayment of principal’ test that courts have consistently applied to determine whether convertible debt instruments are regarded as ‘debt’ or ‘equity’.*
IFCI LIMITED
IFCI Limited arose in the context of a corporate insolvency resolution process (“CIRP”) under the Insolvency and Bankruptcy Code, 2016. IFCI Limited (“IFCI”), an Indian company, made an investment in IVRCL Chengapalli Tollways Limited (“ICTL”) for constructing a highway by subscribing to CCDs of ICTL. IFCI’s investment was a domestic one that was not covered by the Indian foreign exchange laws.
Subsequently, the highway project ran into financial difficulties and CIRP proceedings were initiated against ICTL. By this time, the CCDs had matured and were automatically convertible into equity shares of ICTL. Even then, IFCI claimed that its investment in the form of CCDs constituted debt and hence, it should be treated as a ‘financial creditor’ in the CIRP. IFCI argued that the resolution professional treated IFCI neither as a ‘shareholder’, nor a ‘financial creditor’, thereby leaving it without a remedy.
Both the National Company Law Tribunal and the National Company Law Appellate Tribunal (“NCLAT”) disagreed with IFCI. In its judgment, the NCLAT reasoned that since CCDs do not contemplate repayment of the principal amount, they must be regarded as equity and not debt. To reach this holding, the NCLAT relied on the ‘repayment of principal’ test laid down by the Supreme Court in Narendra Kumar Maheshwari v. Union of India (“Narendra Kumar Maheshwari”).
The NCLAT also relied on the Reserve Bank of India’s master direction on foreign investment in India to rule against IFCI. The master direction expressly states that
“debentures which are fully, compulsorily and mandatorily convertible are treated as equity instruments.”
IFCI filed an appeal against the NCLAT’s judgment before the Supreme Court. The Supreme Court upheld the NCLAT’s ruling and, in doing so, affirmed the ‘repayment of principal’ test laid down in Narendra Kumar Maheshwari.
REPAYMENT OF PRINCIPAL’ TEST
In Narendra Kumar Maheshwari, the Supreme Court came up with a test to determine whether a convertible debenture would be regarded as debt or equity. The test is simple: Do the terms of the convertible debenture postulate repayment of the borrowed principal amount? If the answer is yes, then the convertible debenture is treated as a debt instrument even though such repayment may be optional and may not occur upon maturity. Conversely, if the convertible debenture’s terms do not contemplate repayment of the principal amount (i.e., conversion into equity shares upon maturity is mandatory), it is to be regarded as an equity instrument.
*Applying this test, the Supreme Court observed that CCDs must be converted into equity shares upon maturity and therefore, the possibility of repayment of the principal amount does not arise. Consequently, the Supreme Court held that CCDs would be treated as equity and not debt.
7.13 In view of the above findings of the Hon’ble Apex Court, I am of the opinion that the AO has correctly treated the FCCDs as equity. But as far as the valuation is considered, the AO has considered the DCF method which was the method employed by the appellant to compute the excess consideration received for valuation of the FCCDs. Hence, I find no reason to interfere with the order of the AO. Grounds raised on this issue are dismissed.
5.8 Being aggrieved by the order of the learned CIT(A), the assessee is in appeal before us.
5.9 The learned AR before us submitted that during the year the assessee issued FCCDs which were to mature and convert into equity only in March 2024. Till the date of conversion, the FCCDs continued to remain debentures and carried a one-time coupon of 24%/34.33%. The interest payable on these FCCDs was also allowed as expenditure and there was no dispute on this aspect.
5.10 The Ld. AR further submitted that the Ld. CIT(A) wrongly relied upon the decision of the Hon’ble Supreme Court in IFCI Ltd. v. Sutanu Sinha. In that case, the CCDs had already matured and stood automatically converted into equity. The decision was rendered in the context of proceedings under the Insolvency and Bankruptcy Code. The Hon’ble Supreme Court itself observed that the character of CCDs as debt or equity would depend upon their maturity status and the facts and circumstances of each case. In the present case, the FCCDs had not matured during the year under consideration and, therefore, the said decision could not be applied to treat them as equity.
5.11 The Ld. AR also relied upon the decision of NCLT Delhi in SGM Webtech Private Limited v. Boulevard Projects Private Limited in (IB) No. 967 (PB), wherein it was held that where debentures have not matured for conversion, they continue to remain debt. Accordingly, it was argued that the FCCDs could not be treated as equity shares during the year and, therefore, section 56(2)(viib) of the Act was not applicable.
5.12 On valuation, the Ld. AR submitted that the AO committed an error in adopting Rs. 352.60 per share based upon an internal working prepared by the assessee for the rights issue made in June 2020. Such internal working was not a valuation report prepared by a registered valuer, as required under the relevant rules, and therefore could not be treated as the FMV for the subsequent FCCD issue.
5.13 It was submitted that the rights issue of Rs. 1.65 crore was made during the Covid-19 period, when the assessee was facing serious financial difficulty and required funds to sustain its business. In contrast, the FCCDs were issued subsequently when economic conditions had started improving. The FCCD funds were raised to complete the brewery project, support the restaurant business, and make a substantial investment in the subsidiary for the acquisition of plant and machinery. Thus, the circumstances, purpose and timing of the two issues were materially different, and their valuations could not be directly compared.
5.14 The Ld. AR submitted that the FCCDs were issued at Rs. 704/- based on a valuation report dated 23.10.2020 prepared by an IBBI-registered valuer under the DCF method and in accordance with applicable RBI/FEMA requirements. The registered valuer had taken into account the investments in subsidiaries, future business plans and relevant industry assumptions.
5.15 Lastly, the Ld. AR emphasized that neither the AO nor the Ld. CIT(A) pointed out any specific defect in the registered valuer’s report or in the assumptions adopted therein. Instead, the authorities simply discarded the registered valuation report and substituted it with the earlier internal working of Rs. 352.60. It was therefore submitted that such substitution was not justified and the addition of Rs. 3,88,31,457/- made u/s 56(2)(viib) of the Act deserved to be deleted.
6. On the other hand, the learned DR supported the orders of the AO and the ld. CIT(A). He submitted that the FCCDs were fully and compulsorily convertible into equity shares and were therefore in the nature of equity instruments. The assessee had issued FCCDs at Rs. 704 each, whereas its earlier valuation of equity shares was only Rs. 352.60 per share. Both valuations were based on the DCF method. The assessee could not justify such a substantial difference in valuation. The learned DR relied on IFCI Ltd. v. Sutanu Sinha and submitted that compulsorily convertible debentures are to be treated as equity. He therefore prayed for dismissal of the appeal.
7. We have heard the rival contentions of both the parties and perused the materials available on record. The short controversy before us is whether the amount received by the assessee on the issue of Fully and Compulsorily Convertible Debentures (FCCDs) during A.Y. 2021-22 can be brought to tax within the scope of section 56(2)(viib) of the Act by treating the FCCDs as equity shares. The assessee issued FCCDs at Rs. 704 each, whereas the AO adopted the value of Rs. 352.60 based upon an earlier internal valuation prepared for the issue of equity shares and consequently made an addition of Rs. 3,88,31,457/- u/s 56(2)(viib) of the Act.
7.1 At the outset, it is necessary to examine the language of section 56(2)(viib) of the Act as applicable to the year under consideration. The provision applies where a closely held company receives, from a resident person, any consideration “for issue of shares” which exceeds the fair market value of such shares. Thus, receipt of consideration for issue of shares is the basic jurisdictional condition for invoking the provision. The section does not use the expression “securities”, “debentures”, “convertible securities” or “instruments convertible into shares”. Similarly, Rule 11UA of the Income Tax Rules provides the mechanism for determination of the FMV of shares and does not create any deeming fiction by which issue of FCCDs is to be regarded as issue of shares.
7.2 In our view, when a taxing provision creates a charge by specifically referring to consideration received for “issue of shares”, its scope cannot be enlarged merely because another financial instrument is compulsorily convertible into shares at a future date. FCCDs may ultimately result in allotment of equity shares, but the issue of an FCCD and its subsequent conversion into an equity share are two separate events. On the date on which consideration is received against the FCCD, what is issued by the company is a debenture carrying its own contractual terms and not an equity share. The possibility or certainty of its future conversion does not alter the nature of the instrument actually issued on that date for the limited purpose of section 56(2)(viib) of the Act. Significantly, there is no deeming provision in section 56(2)(viib) of the Act treating an FCCD as a share before its conversion.
7.3 This distinction becomes more important in the facts before us. The FCCDs issued by the assessee were to mature and convert into equity only in March 2024. During the year under consideration, they had not reached the stage of conversion. They carried a one-time coupon of 24%/34.33% and the interest payable thereon was treated as expenditure, which was not disputed by the Revenue. Thus, in the relevant previous year, the assessee had issued FCCDs and not equity shares.
7.4 We have also considered the reliance placed by the Ld. CIT(A) on the decision of the Hon’ble Supreme Court in IFCI Ltd. v. Sutanu Sinha. In our considered view and humble understanding, the said decision does not justify application of section 56(2)(viib) of the Act to the FCCDs in the present case. The controversy before the Hon’ble Supreme Court arose in the context of a corporate insolvency resolution process under the Insolvency and Bankruptcy Code. More importantly, by the relevant point of time in that case, the CCDs had already matured and had become automatically convertible into equity shares. In the case before us, however, the FCCDs had not matured during the relevant previous year, and their conversion was due only in March 2024. Therefore, the factual stage at which the character of the instrument was examined in IFCI Ltd. was materially different.
7.5 Even otherwise, the question before us is not whether an FCCD can be regarded as equity for every regulatory, insolvency or commercial purpose. The narrower question is whether receipt of money against an FCCD can be regarded as consideration received “for issue of shares” within the specific language of section 56(2)(viib) of the Act. The character assigned to a convertible instrument under the RBI/FDI framework or under the Insolvency and Bankruptcy Code cannot, in the absence of an express provision in the Income-tax Act, enlarge the charging language employed by Parliament in section 56(2)(viib) of the Act.
7.6 In this regard, useful guidance is also available from the decision of the Mumbai Tribunal in DCIT v. Rankin Infrastructure (P.) Ltd. [2022] 142 taxmann.com 37. In that case, convertible debentures had been issued in an earlier year and were subsequently converted into preference shares. It was held that section 56(2)(viib) of the Act requires the receipt of consideration and issue of shares to occur in the manner contemplated by the provision and that conversion of debentures into shares without fresh receipt of consideration could not by itself attract section 56(2)(viib) of the Act. This reasoning reinforces the distinction between the original issue of a convertible debenture and the subsequent issue of shares upon its conversion. The relevant observation & finding of the Mumbai Tribunal is extracted as under:
10. Considered the rival submissions and material placed on record, we observe that originally assessee has issued Optionally Fully Convertible Debentures to M/s. Ranon Infrastructure Pvt. Ltd., and allotted OFCDs on 4-4-2011, 21-7-2011 and 21-3- 2012. The above issue prices of the OFCDs includes share premium. During this assessment year assessee has only converted OFCDs into non-cumulative preference shares at the same price of OFCD. Therefore, since assessee has converted the OFCDs into non-cumulative preference share during this assessment year the Assessing Officer has invoked the provisions of section 56(2)(viib) of the Act by interpreting that, section 56(2)(viib) of the Act does not contemplate receipts of funds but it deals only with issues of shares. Further, we observe that the Ld.CIT(A) has addressed this issue in detail in his order in Para No 5.13 of the order and he held, the section 56(2)(viib)of the Act is clear that the words used in the section are “where a company, not being a company in which the public are substantially interested, receives in any previous year…….”. Therefore, the words used are receives. He decided the issue in favour of the assessee. In our view, the “receives” means not only issue of shares but also receipts of share consideration during the same assessment year. One cannot interpret the law merely on the basis of issue of shares or from receipt of consideration, it has to be issue of shares and receipt of consideration during the same assessment year. It is needless to say that issue of shares includes allotment of shares. In our considered view, Ld.CIT(A) has discussed this issue elaborately in his order and we do not find any reason to interfere with the findings of the Ld.CIT(A). Accordingly, ground raised by the revenue is dismissed.
7.7 We are also aware of the decision of the Kolkata Tribunal in Milk Mantra Dairy (P.) Ltd. v. DCIT [2022] 140 taxmann.com 163. That case dealt with the tax effect of converting CCDs into equity shares. On its facts, the Tribunal gave a wider meaning to “consideration”. This included the extinguishment of debt and interest obligations. The facts in the present case are different. Here, the addition was made in the year in which the FCCDs were issued. This was before they were converted into equity shares. Therefore, the case of Milk Mantra Dairy does not support the view that every receipt on the issue of FCCDs is consideration for the issue of shares.
7.8 There is another aspect of the matter. If the Revenue’s interpretation is accepted, the consideration received at the stage of issue of FCCDs would be treated as consideration for issue of shares even though no shares were issued during that year. Such an interpretation would require us to read the words “FCCDs or other securities convertible into shares” into section 56(2)(viib) of the Act. This, in our view, is impermissible. A deeming provision which brings a capital receipt to tax has to operate within the field specifically defined by the legislature and cannot be extended to a transaction which the statutory language does not cover.
7.9 Once we hold that the issue of FCCDs during the year does not constitute an “issue of shares” for the purpose of section 56(2)(viib) of the Act, the entire exercise undertaken by the AO of comparing the FCCD issue price of Rs. 704 with the earlier equity valuation of Rs. 352.60 loses its foundation. The question whether Rs. 704 was the correct FMV under Rule 11UA, therefore, becomes academic for deciding the addition made in the year under consideration.
7.10 Nevertheless, we also find merit in the assessee’s grievance regarding the manner in which the valuation was rejected. The value of Rs. 352.60 relied upon by the AO was an internal working prepared in connection with a rights issue during the Covid-19 period. On the other hand, the FCCDs were issued on the basis of a valuation report prepared by an IBBI-registered valuer under the DCF method. The assessee explained that the two transactions took place under materially different commercial circumstances and that the FCCD funds were intended, inter alia, for expansion and investment in subsidiaries. Neither the AO nor the Ld. CIT(A) pointed out any specific defect in the registered valuer’s report or its underlying assumptions before substituting it with the earlier internal working. However, in view of our finding on the primary jurisdictional issue, we do not consider it necessary to adjudicate the correctness of the respective valuations any further.
7.11 In view of the above discussion, we hold that the FCCDs issued by the assessee during the year under consideration, which were to be converted into equity shares only at a future date, cannot be equated with the issue of equity shares for the purpose of section 56(2)(viib) of the Act. The consideration received against such FCCDs during A.Y. 2021-22 is therefore outside the scope of section 56(2)(viib) of the Act. Accordingly, the finding of the Ld. CIT(A) treating the FCCDs as equity shares is set aside and the AO is directed to delete the addition of Rs. 3,88,31,457/- made u/s 56(2)(viib) of the Act. The grounds raised by the assessee on this issue are accordingly allowed.
8. In the result, the appeal of the assessee is hereby allowed.
Order pronounced in the open court on 31st August, 2026
