Applicability of Section 56(2)(viia) & 56(2)(x) of the Income Tax Act, 1961 on Fresh /Bonus/Right Issue & Buy Back of Shares: An Undying Conundrum!!
The provisions of section 56(2)(viia) of the Income Tax Act were inserted w.e.f. the Finance Act 2010, and read as under:
Section 56(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 :—
(viia) where a firm or a company not being a company in which the public are substantially interested, receives, in any previous year, from any person or persons, on or after the 1st day of June, 2010 [but before the 1st day of April, 2017], any property, being shares of a company not being a company in which the public are substantially interested,—
(i) without consideration, the aggregate fair market value of which exceeds fifty thousand rupees, the whole of the aggregate fair market value of such property;
(ii) for a consideration which is less than the aggregate fair market value of the property by an amount exceeding fifty thousand rupees, the aggregate fair market value of such property as exceeds such consideration :
Provided that this clause shall not apply to any such property received by way of a transaction not regarded as transfer under clause (via) or clause (vic) or clause (vicb) or clause (vid) or clause (vii) of section 47.
Explanation.—For the purposes of this clause, “fair market value” of a property, being shares of a company not being a company in which the public are substantially interested, shall have the meaning assigned to it in the Explanation to clause (vii).
The provisions of above section 56(2)(viia) are applicable uptill 1.4.2017 and w.e.f. 1.4.2017 a new similar section 56(2)(x) has been inserted, which reads as under:
“(x) where any person receives, in any previous year, from any person or persons on or after the 1st day of April, 2017,—
(c) any property, other than immovable property,—
(A) without consideration, the aggregate fair market value of which exceeds fifty thousand rupees, the whole of the aggregate fair market value of such property;
(B) for a consideration which is less than the aggregate fair market value of the property by an amount exceeding fifty thousand rupees, the aggregate fair market value of such property as exceeds such consideration”.
At present, the Revenue Authorities are pressing into service the above section 56(2)(viia) {applicable uptill 1.4.2017} and section 56(2)(x) {applicable from 1.4.2017}, to all kinds of receipts of shares by the specified company or firm as a result of subsequent transfer of unlisted shares as well as fresh issuance of shares including by way of bonus shares, rights shares and preference shares or transactions of similar nature.
The Central Board of Direct Taxes had issued Circular No. 10/2018 dated 31.12.2018 to clarify that provisions of section 56(2)(viia) of the Income-tax Act, 1961 being anti-abuse provisions shall not be applicable in cases of receipt of shares by the specified company or firm as a result of fresh issuance of shares including by way of bonus shares, rights shares and preference shares or transactions of similar nature by the specified company.
However, on reconsideration it was observed by CBDT that the matter relating to interpretation of the term ‘receives’ used in section 56(2)(viia) of the act is pending before judicial forums and stakeholders have sought clarifications on other similar provisions in section 56 of the Act. Accordingly, with the idea of issuing a fresh comprehensive circular on the subject, the said CBDT Circular no. 10/2018 was withdrawn by CBDT Circular no. 02/2019 dated 04.01.2019. While withdrawing the circular no. 10/2018, it was also clarified that the said circular shall be considered to have never been issued.
Subsequently, it was clarified by CBDT vide its circular no. 3/2019 dated 21.01.2019 that the view, taken in Circular No. 10/2018 (subsequently withdrawn by circular no. 02/2019) that section 56(2)(viia) of the Act would not apply to fresh issuance of shares, would not be a correct approach, as it could be subject to abuse and would be contrary to the express provisions and the legislative intent of section 56(2)(viia) or similar provisions contained in section 56(2) of the Act. Accordingly, it was further clarified that any view expressed by the Board in Circular No. 10/2018 shall be considered to have never been expressed and, the said circular shall not be taken into account by any Income-tax authority in any proceedings under the Act.
Author’s Humble Take on above Flip Flop:
The Hon’ble CBDT has withdrawn its Circular No. 10/2018 dated 31.12.2018 concerning the non-applicability of provisions of section 56(2)(viia) of the Income Tax Act, in cases of receipt of shares by the specified company or firm as a result of fresh issuance of shares including by way of bonus shares, rights shares and preference shares or transactions of similar nature, on the reasoning that it was contrary to the legislative intent.
However, Ironically, the view expressed in the said CBDT Circular No. 10/2018 dated 31.12.2018, suggesting the non-applicability of provisions of section 56(2)(viia) of the Income Tax Act, in cases of receipt of shares by the specified company or firm as a result of fresh issuance of shares including by way of bonus shares, rights shares and preference shares or transactions of similar nature, was actually in complete harmony and conformity with the legislative intent of introduction of the said anti-abuse provision of section 56(2)(viia) by the Finance Act 2010.
The Explanatory Memorandum to Finance Bill 2010 explaining the rationale of introduction of the said section 56(2)(viia), interalia provided that,
“In order to prevent the practice of transferring unlisted shares at prices much below their market value, it is proposed to amend Section 56(2) to also include within its ambit, transactions undertaken in shares of a company (not being a company in which public are substantially interested) either for inadequate consideration or without consideration where recipient is a Firm or a Company”
Thus it is amply clear and duly evident from above that the legislative intent of introduction of section 56(2)(viia) was to prevent the practice of transferring of unlisted shares at prices below their fair market value. The expression “transfer” has altogether different connotation and meaning than the expression “issuance” and as such the provisions of said section 56(2)(viia) were meant to be applicable in cases of receipt of shares by a company or a firm on subsequent transfer of unlisted shares after their initial issuance by the issuing company.
Concluding Remarks:
Therefore, in view of the above stated legislative intent of introduction of section 56(2)(viia) of the Act and in order to give the much needed flexibility to the corporate sector in raising its capital for its genuine financial needs, a suitable amendment either by way of insertion of an explanation or a proviso in section 56(2)(viia) applicable uptill 1.4.2017 and section 56(2)(x) (applicable from 1.4.2017) of the Act to the effect that provisions of the said section are applicable only in cases of receipt of shares as a result of transfer of such shares and are not applicable in cases of receipt of shares by the specified company or firm as a result of fresh issuance of shares including by way of bonus shares, rights shares and preference shares or transactions of similar nature, is desirable and should be considered by the Finance Ministry and CBDT in right earnest so as to ensure the fulfilment of the Government’s objective of “Ease of Doing Business” in real and effective sense and manner.
“Law is not Law,
if it violates the principles of eternal justice…”
– Lydia Maria Child
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