In a significant ruling by the Income Tax Appellate Tribunal (ITAT) Delhi, dated 13th December 2023, the case of ITO Vs K V Global Pvt. Ltd. highlighted the applicability of Section 56(2)(viib) of the Income Tax Act, 1961, concerning share premium transactions between subsidiary and holding companies. This decision provides clarity on the taxation aspect of share premiums recorded by companies, especially in cases where shares are issued at a premium to their holding companies.
K V Global Pvt. Ltd., engaged in the import and trade of crude palm oil and coal, issued 52,60,000 equity shares at a premium of Rs.5/- per share to its holding company, K.V. Aromatics Pvt. Ltd., during the Assessment Year (AY) 2016-17. The Assessing Officer (AO) initially added a sum of Rs.2,63,00,000/- to the total income of the assessee under Section 56(2)(viib) of the Act, on grounds that the share premium charged was in excess of the Fair Market Value (FMV). However, the CIT(A) deleted this addition, ruling in favor of the assessee.
The key issue before ITAT was the applicability of Section 56(2)(viib) to the share premium transactions between the assessee and its holding company. ITAT observed that the legislative intent behind Section 56(2)(viib) is to curb the circulation of unaccounted money through overvaluation in share premium transactions. However, when the transaction involves a holding and subsidiary company, the premise of unaccounted money does not stand, as it effectively remains within the same economic entity.
The ITAT affirmed the CIT(A)’s decision by acknowledging that:
The ITAT Delhi’s ruling in the case of ITO Vs K V Global Pvt. Ltd. sets an important precedent for share premium transactions between holding and subsidiary companies. It clarifies that such transactions are exempt from the purview of Section 56(2)(viib), as they do not result in any taxable income under the said section. This decision will significantly impact how companies structure their share premium transactions, ensuring that they comply with the legal framework while optimizing their tax liabilities. The ruling reinforces the principle that the tax authorities must consider the nature of intra-group transactions and the legislative intent behind tax provisions before making additions to the assessable income.
FULL TEXT OF THE ORDER OF ITAT DELHI
The captioned appeal has been filed by the Revenue against the order of the Commissioner of Income Tax (Appeals)-V, New Delhi (‘CIT(A)’ in short) dated 29.08.2019 arising from the assessment order dated 17.12.2018 passed by the Assessing Officer (AO) under Section 143(3) of the Income Tax Act, 1961 (the Act) concerning AY 2016-17.
2. The grounds of appeal raised by the Revenue read as under:
“1. Whether in the circumstances of the case and law, the ld. CIT(A) is correct in deleting the addition of Rs.2,63,00,000/- made by the ld. AO under Section 56(2)(viib) on account of excess share premium recorded by the assessee.
2. Whether in the circumstances of the case and law, the ld. CIT(A) is correct in deleting the addition of Rs.77,20,700/- made by the ld. AO under Section 68 on account of unexplained cash credit in terms of unsecured loans.”
3. Briefly stated, the assessee-company is engaged in import and trade of crude palm oil and coal business. The assessee filed return of income declaring total income at a loss of 1,61,70,427/- for the Assessment Year 2016-17 in question. The return filed by the assessee was subjected to scrutiny assessment under Section 143(3) of the Act.
3.1 In the course of the assessment proceedings, the Assessing Officer inter alia observed that the assessee has issued 52,60,000 equity shares at a premium of Rs.5/- per share to one of the subscriber K.V. Aromatics Pvt. Ltd. in January, 2016. The equity shares were also issued to other three subscribers at about the same period without any premium. The Assessing Officer recomputed the Fair Market Value (FMV) of the equity shares at a negative figure of Rs.1.11 crore. The AO accordingly invoked the provisions of Section 56(2)(viib) and held that the share premium charged on issue of equity shares to KV Aromatics is in excess of FMV and a sum of Rs.2,63,00,000/- collected by way of share premium from ‘KV Aromatics’ is susceptible to tax. Accordingly, the aforesaid sum was added to the total income of the assessee.
4. Aggrieved, the assessee preferred appeal before the CIT(A). It was pointed out before the CIT(A) that the aforesaid company KV Aromatics Pvt. Ltd. is a holding company, holding 51% share of the assessee-company. Besides, the net worth of the assessee company is not negative for Assessment Year 2016-17 in question which is corroborated by the valuation report. The premium charged is meager and collected from its own holding company.
Therefore, in effect, the existing shareholder has been issued additional shares at a small premium of Rs.5 per share in consonance with valuation report. The CIT(A) took note of various factual submissions and judicial pronouncements and also called for remand report from the AO. On consideration of submissions and material placed, the CIT(A) adjudicated the issue in favour of the assessee. The relevant operative paragraph of the order of the CIT(A) is reproduced hereunder for ready reference:
“6. In ground no.2 the appellant disputed addition of Rs. 2,63,00,000/on account of share premium u/s. 56(2)(viib) of the Act.
6.1 During the year under consideration, the appellant has issued 52,60,000 equity shares to M/s K.V. Aromatics Pvt. Ltd. having face value of Rs. 10/- each with a premium of Rs. 5/- on each share, thereby a total premium has been received for Rs. 2,63,00,000/-. Other shares were also issued however, no premium has been taken. Further, the K.VAromatics Pvt. Ltd. is its holding company and other share holders are also the share holder of appellant company.
6.2 During assessment proceedings, it was observed by the AO that this share premium is excessive considering the financials of the appellant and NAV of appellant’s shares is negative therefore, share premium value of Rs. 5/- per share is not substantiated. In absence of any satisfactory reply, the entire addition has been made, invoking provisions of section 56(2)(viib) of the Act.
6.3 It has been vehemently argued, as reproduced earlier that the provisions of section 56(2)(viib) are not applicable in the case of appellant. It is contended that the valuation report has been prepared by the expert valuer/auditor and in accordance with the provisions of section 56(2)(viib), whereas per Rule 11UA(2), the appellant is entitled for the valuation of fare market value (FMV) as per the DCF method. It is argued that the intent of legislature is to curb the black money and there cannot be involvement of any such unaccounted money as the funds have been sourced through its holding company.
6.4 It is further argued that the valuation has been done as per DCF method which is duly acceptable as per the prescribed Rules. It is further stated that as per explanation (a)(i) of the section 56(2)(viib), the fair market value of the share shall be the value, as may be determined in accordance with the prescribed method. In the present case, the appellant has gone by the prescribed method i.e. DCF method which is supported by the report of independent auditor and is in accordance with law. Therefore, it is not open to the AO to change the method, adopted by the appellant. Further, no cogent reasoning has been submitted while rejecting the valuation adopted by the appellant. The appellant provided valuation report, which is as per the DCF method.
6.5 The contention of the appellant has been examined. The fair market value as given by the appellant has been rejected which was based on the DCF method of valuation without any cogent material on record except on the basis that there is a negative book value of shares.
6.6 On going through the contentions of the appellant, it is seen that the working has been made by an independent valuer, submitting the valuation of share as per discount cash flow method. Further, as per the provisions of law, the appellant can take higher of the amount between the working as per Rule 11UA (DCF method) or on the basis of the value of shares considering the market value of assets, intangible assets and projected profit (NAV method).
6.7 In the present case, the working given by the appellant has been based on the value of the shares, taking into account the projected business and other parameters as per auditor’s report.
6.8 The working provided as per Rule 11UA(2) has 2 limbs either at FMV of unquoted equity share as per formula (A-L) *(PV)/(PE) or as per the FMV worked out for the unquoted shares determined by a valuer/CA/merchant banker etc. as per discount free cash flow method. It is at the option of assessee to choose between two whichever is higher. In the present case, the appellant has opted for the second option for working out the fair market value of shares duly supported by report of a Chartered Accountant.
6.9 On the other hand, AO has not provided any sound reasoning or not brought on record any material to counter the argument or to negate the submissions of the appellant. He has rejected the projection with the contention that the present NAV is negative, without commenting upon the DCF method for the projections made. It is pertinent to note that projections of future profits are only the estimates and not the exact working of future profits. This has also been held by Hon’ble ITAT Delhi Bench in the case of India Today Online Pvt. Ltd. (Supra) that DCF method is a recognized method where future projections of various factors by applying hindsight view and it cannot be matched with the actual performance.
6.10 Therefore it is clear that as per the provisions of law, the appellant has worked out the FMV, taking into consideration the future projections, using DCF method and accompanied by the report of CA, which is higher than the negative NAV, worked out by the Assessing Officer. Therefore, the appellant is entitled to take higher amount, as provided in the law.
6.11 Section 56(2)(vii)(b) read with Explanation and applicable Rules has specifically provided that the fair market value of the unquoted shares shall be determined as per the prescribed methods and shall be taken whichever is higher.
6.12 In the following case, the Hon’ble ITAT, Jaipur has held that AO cannot force the appellant to select a different method, especially when conditions are fulfilled for method of valuation.
M/s. Rameshwaram Strong Glass Pvt Ltd Vs ITO; 2018-TIOL1358- ITAT-JAIPUR
“Whether when in terms of Rule 11UA(2)(b), if the assessee is entitled to choose a particular method of valuation of his unquoted equity shares, the AO can still force the assessee to select a different one – NO: ITAT.
6.13 The appellant has heavily relied upon the case of M/s Cinestaan Entertainment Pvt. Ltd. (Supra), where the Hon’ble ITAT, Delhi in the recent judgment held that:-
31………………….. Any businessman or entrepreneur, visualise the business based on certain future projection and undertakes all kind of risks. It is the risk factor alone which gives a higher return to a businessman and the income tax department or revenue official cannot guide a businessman in which manner risk has to be undertaken. Such an approach of the revenue has been judicially frowned by the Hon’ble Apex Court on several occasions. Commercial expediency has to be seen from the point of view of businessman. Here in this case if the investment has made keeping assessee’s own business objective of projection of films and media entertainment, then such commercial wisdom cannot be questioned. Even the prescribed Rule 11UA (2) does not give any power to the Assessing Officer to examine or substitute his own value in place of the value determined or requires any satisfaction on the part of the Assessing Officer to tinker with such valuation….
32. Section 56(2)(viib) is a deeming provision and one cannot expand the meaning of scope of any word while interpreting such deeming provision. If the statute provides that the valuation has to be done as per the prescribed method and if one of the prescribed methods has been adopted by the assessee, then Assessing Officer has to accept the same and in case he is not satisfied, then we do not we find any express provision under the Act or rules, where Assessing Officer can adopt his own valuation in DCF method or get it valued by some different Valuer. There has to be some enabling provision under the Rule or the Act where Assessing Officer has been given a power to tinker with the valuation report obtained by an independent valuer as per the qualification given in the Rule 11U. Here, in this case, Assessing Officer has tinkered with DCF methodology and rejected by comparing the projections with actual figures. The Rules provide for two valuation methodologies, one is assets-based NAV method which is based on actual numbers as per latest audited financials of the assessee company.
These projections are based on various factors and projections made by the management and the Valuer, like growth of the company, economic/market conditions, business conditions, expected demand and supply, cost of capital and host of other factors. These factors are considered based on some reasonable approach and they cannot be evaluated purely based on arithmetical precision as value is always worked out based on approximation and catena of underline facts and assumptions. Nevertheless, at the time when valuation is made, it is based on reflections of the potential value of business at that particular time and also keeping in mind underline factors that may change over the period of time and thus, the value which is relevant today may not be relevant after certain period of time…
33. In any case, if law provides the assessee to get the valuation done from a prescribed expert as per the prescribed method, then the same cannot be rejected because neither the Assessing Officer nor the assessee have been recognized as expert under the law.”
6.14 It is clear from the above judgment by the Hon’ble Jurisdictional ITAT that neither AO has any power or expertise to change the method of valuation nor it can reject a valid valuation by a competent person say a CA in this case. The law has to be followed in later and spirit. The facts and ratio laid down by the Hon’ble ITAT in the above referred case are squarely applicable to the appellant and hence respectfully following the same, it is held that the addition u/s. 56(2)(viib) with respect to change in the method of valuation is not in accordance with law.
6.15 The appellant has elaborately disputed and distinguished the fact of the decision in the case of Agro Portfolio Pvt. Ltd. from that of the case of appellant. In the said case, the Hon’ble ITAT allowed the AO’s working of NAV value on the ground that no cogent reasoning was provided in the report and the veracity of the data supplied was also not justified. In the case of appellant as well as in the case of M/s Cinestaan Entertainment Pvt. Ltd., the valuation report is duly supported by the facts and figures. It is trite law that the projections cannot be equated with 100% actual performance which is also confirmed by Hon’ble ITAT Delhi in the case of India Today Online Pvt. Ltd (Supra).
6.16 Therefore, looking to the facts and circumstances of this case, considering appellant’s submissions and in law, which is further supported by the judgment of Hon’ble ITAT Delhi in the case of Cinestaan Entertainment Pvt. Ltd. (Supra) and other case laws and as discussed in detail in the submission of appellant, it cannot be said that the value adopted by the appellant is liable to be rejected or subjected to tax u/s. 56(2)(viib) of the Act, enforcing the change of method of valuation of FMV of shares. Accordingly, the valuation done by appellant is found to be in accordance with law. Therefore in view of above discussions and considering the extant law, this addition is directed to be deleted. Thus the appellant gets a relief of Rs.2,63,00,000/-. This ground of appeal is allowed.”
5. Aggrieved by the relief granted by the CIT(A), the Revenue is in appeal before the Tribunal.
6. We have considered the rival submissions and perused the first appellate order and the assessment order. The documents referred to and also case laws referred in the course of hearing by the respective sides have been taken into account.
6.1 The Revenue has controverted the action of the CIT(A) on the touchstone of Section 56(2)(viib) of the Act towards allotment of equity shares to the subscriber KY Aromatics Pvt. Ltd. which is the existing shareholder, holding 51% of the equity share of the assessee-company. The effect of issues of shares to holding company at a premium has been examined by the Co-ordinate Bench of Tribunal in the case of BLP Vayu (Projects-1) Pvt. Ltd.reported in (2023) 151 taxmann.com 47 (Del-Trib.). The relevant operative paragraph of the order of the Tribunal is hereunder:
“11.1 As per case records, it is an undisputed fact that the shares have been allotted at a premium to its 100% holding company. Thus, applicability of Section on 56(2)(viib) has to be seen in this perspective. The Co-ordinate Bench of Tribunal in DCIT vs. Ozone India Ltd. in ITA No.2081/Ahd/2018 order dated 13.04.2021 in the context of Section 56(2)(viib) has analyzed the deeming provisions of Section 56(2)(viib) of the Act threadbare and inter alia observed that the deeming clause requires to be given a schematic interpretation. The transaction of allotment of shares at a premium in the instant case is between holding company and it is subsidiary company and thus when seen holistically, there is no benefit derived by the assessee by issue of shares at certain premium notwithstanding that the share premium exceeds a fair market value in a given case. Instinctively, it is a transaction between the self, if so to say. The true purport of Section 56(2)(viib) was analyzed in Ozone case and it was observed that the objective behind the provisions of Section 56(2)(viib) is to prevent unlawful gains by issuing company in the garb of capital receipts. In the instant case, not only that the fair market value is supported by independent valuer report, the allotment has been made to the existing shareholder holding 100% equity and therefore, there is no change in the interest or control over the money by such issuance of shares. The object of deeming an unjustified premium charged on issue of share as taxable income under Section 56(2)(viib) is wholly inapplicable for transactions between holding and its subsidiary company where no income can be said to accrue to the ultimate beneficiary, i.e., holding company. The chargeability of deemed income arising from transactions between holding and subsidiary or vice versa militates against the solemn object of Section 56(2)(viib) of the Act. In this backdrop, the extent of inquiry on the purported credibility of premium charged does not really matter as no prejudice can possibly result from the outcome of such inquiry. Thus, the condition for applicability of Section 263 for inquiry into the transactions between to interwoven holding and subsidiary company is of no consequence. We also affirmatively note the decision of SMC Bench in the case of KBC India Pvt. Ltd. vs. ITO in ITA No.9710/Del/2019 order dated 02.11.2022 (SMC) where it was observed that Section 56(2)(viib) could not be applied in the case of transaction between holding company and wholly owned subsidiary in the absence of any benefit occurring to any outsider.”
6.2 The Co-ordinate Bench has essentially observed that where the allotment has been made to existing shareholders, the deeming provisions of Section 56(2)(viib) would not ordinarily be applicable. This apart, the assessee, in the instant case, has also dislodged the observation of the Assessing Officer that the net worth at the time of issuance of shares were in negative by adducing valuation report. As per the valuation report, the FMV has been determined at Rs.14.815 per share which is at par with the FMV at which shares have been issued to the holding company. Thus the premium charged is supportable by the valuation report and the premium charged is quite negligible and charged to existing shareholder. Thus effectively, the benefit if any arising to the company in turn benefits to the subscriber having pre-existing right in the company. Thus, in our view, the conclusion drawn by the CIT(A) cannot be faulted either on facts or in law.
7. Without reiterating the process reasoning adopted by the CIT(A), we endorse the same and decline to interfere therewith.
8. In the result, the appeal of the Revenue is dismissed.
Order pronounced in the open Court on 13/12/2023