Rajeev Ratanlal Tulshyan Vs ITO (ITAT Mumbai)
Transfer of shares without consideration or at a price lower than the fair market value (FMV) does not attract Section 56(2)(vii) of Income Tax Act, 1961.
Conclusion: In present facts of the case, Assessment Year (AY) 2014-15 was in consideration, wherein it was held that transfer of shares of a company to a firm or a company, instead of an individual or an HUF, without consideration or at a price lower than the fair market value does not attract Section 56(2)(vii) of the Income Tax Act.
Facts: In present facts of the case, the assessee was a director and a major shareholder in an entity namely M/s Kennington Fabrics Private Limited (KFPL). During the year, KFPL offered right issue and the assessee was allotted 3.95 Crores shares of KFPL at face value of Re.1/- each in the right issue. However, it was alleged by Ld. AO that the consideration of Re.1/- per share was less than fair market value (FMV) of shares as calculated in accordance with the provisions of Sec.56(2)(vii)(c)(ii) read with rule 11U & 11UA and therefore, the difference between FMV and the consideration paid by the assessee would be taxable in the hands of the assessee u/s 56(2)(vii).
The assesse before the Hon’ble Tribunal, relied on the decision of Mumbai Tribunal in Sudhir Menon HUF, (45 taxmann.com 176), wherein it was held that in case of proportionate allotment of shares, there would be no taxability u/s 56(2)(vii)(c)(ii).However, in case of disproportionate allotment of shares, there provisions may get attracted.
In present facts, the AO noticing that the percentage of share holding of the assessee in KFPL increased from 90.37% as on 31/03/2013 to 96.88% as on 31/03/2014, and was of opinion that there was disproportionate allotment of shares and therefore, the stated provisions would apply in assessee’s case.
The Hon’ble Tribunal considered the submissions of the Assessee during appellate proceedings pertaining to CBDT Circular No. 5 of 2010 dated 03/06/2010 which provided that the newly introduced provisions of Sec. 56(2)(vii) were anti-abuse measures. Similarly, CBDT Circular No.1 of 2011 provided that these provisions were introduced as a counter evasion mechanism to prevent laundering of unaccounted income. The provisions were intended to extend the tax net to such transactions in kind. The intent was not to tax the transactions entered into the normal course of business and trade, the profits of which are taxable under specific head of income.
The intention of the provisions was to check evasion of tax and the provisions were introduced as anti-abuse provisions. The amendment was introduced to overcome the money laundering activities undertaken on abolition of Gift Tax Act; Since the Gift tax Act was not applicable to issue of shares, the provisions of Sec.56(2) would not apply to transaction of such nature as per the decision of Bangalore Tribunal in DCIT V/s Dr. Rajan Pal (ITA No.1290/Bang/2015). Another argument was that that the provisions of Sec.56(2)(vii) would be applicable to recipient of the property or money. Such property includes shares and securities being capital assets of the assessee. However, in the present case, the shares come into existence only on allotment. The term allotment would mean the appropriation out of previously un-appropriated share capital of a company of a certain number of shares to a person. Till such allotment, the shares do not exist as such. It is only on allotment that the shares comes into existence. As held by Hon’ble Supreme Court in Khoday Distilleries Ltd. (CA No.6654 of 2008), allotment of shares is a creation of shares and not a transfer of shares, There is vital difference between the two. An allotment is the creation of shares by appropriation out of the unappropriated share capital to a particular person. A share is a chose in action. A chose in action implies existence of some person entitled to the rights in action in contradistinction to a subscriber and the purchase of shares from an existing shareholder. The first case is that of creation whereas the second case is that of transfer. An allotment is not a transfer and does not attract Section 4(1 )(a) of the Gift Tax Act. It was, therefore, contended that the property must be in existence at the time when it was received from a person. In the present case the shares come into existence only after the shares have been allotted and therefore, the provisions of Sec.56(2)(vii) could not be made applicable.
The Hon’ble Tribunal while allowing the Assess’s Appeal relied on Sudhir Menon HUF V/s ACIT (45 taxmann.com 176) and observed that the coordinate bench held that as long as there was no disproportionate allotment i.e. shares are allotted pro-rata to the shareholders, based on their existing holdings, there is no scope for any property being received by them on the said allotment of shares; there being only an apportionment of the value of their existing holding over a larger number of shares. In such a case, the provisions of Sec.56(2)(vii)(c) would not get attracted. A higher than proportionate or a non-uniform allotment though would, and on the same premise, attract the rigor of the provision. This is only understandable inasmuch as the same would only be to the extent of the disproportionate allotment and, further, by suitably factoring in the decline in the value of the existing holding.
The provision of Section 56(2)(vii) were anti-abuse provision inserted post abolition of Gift Tax Act. The same is evident from CBDT Circular No. 05/2010 dated 03/06/2010 which provided that Section 56 is being introduced as an anti-abuse measure. The same is fortified in CBDT Circular No. 01/2011 dated 06/04/2011 which also provided that these provisions are anti-abuse provisions which were applicable only if an individual or an HUF is the recipient. Therefore, transfer of shares of a company to a firm or a company, instead of an individual or an HUF, without consideration or at a price lower than the fair market value does not attract the anti-abuse provision.
The transactions were considered to be ordinary transactions of issue of right shares to existing shareholders in proportion to their existing shareholding and therefore, no case of abuse or tax evasion could be made out against the assessee.
The Hon’ble Tribunal relied upon DCIT V/s Dr. Ranjan Pai (ITA No. 1290/Bang/2015) and observed that the intent of introducing the provisions was anti-abusive measures still remain intact and there is no reason to depart from the understanding that the provisions were counter evasion mechanism to prevent laundering of unaccounted income. Therefore, the same do not apply to genuine issue of shares to existing shareholders.
FULL TEXT OF THE ORDER OF MUMBAI DELHI
1.1 Aforesaid appeal by revenue for Assessment Year (AY) 2014-15 arises out of the order of Ld. Commissioner of Income-Tax (Appeals)-21, Mumbai, [in short referred to as ‘CIT(A)’] dated 16/06/2017 in the matter of assessment framed by learned Assessing Officer (AO) u/s 143(3) on 30/12/2016. The revenue has filed revised grounds which read as under: –
1. On the facts and in the circumstances of the case and in law, the Ld. CIT(A) erred in restricting the addition of Rs.42,87,75,000/- to Rs.1,50,87,320/- under section 56(2)(vii)(c)(ii) of the Income-tax Act, without appreciating the fact that the addition was made as income from other sources totalling to Rs.42,87,75,000/-.
2. On the facts and in the circumstances of the case and in law, the Ld. CIT(A) erred in restricting the addition without appreciating the fact that the assessee has failed to discharge its onus of explaining the charging @ Rs.10.85 per share with proper explanations and supporting evidences.
1.2 The assessee has filed cross-objection on following grounds: –
(a) The Id. CIT(A) erred in facts and law in applying the provisions of section 56(2)(vii)(c)(ii) of the Act and confirming the addition to the extent of Rs.1,50,87,320/-.
(b) The Id. CIT(A) erred in facts and law in not appreciating that the appellant had applied for and was allotted shares in right issue only to the extent to which he was entitled to in proportion of his existing-shareholding and therefore section 56(2)(vii)(c)(ii) ought not have been invoked.
(c) The Id. CIT(A) erred facts and law in not appreciating that the appellant had been in fact “allotted” the right shares on creation which cannot be equated to as “received” as envisaged u/s. 56(2)(vii)(c)(ii) of the Act.
(2) Without prejudice and without accepting the applicability of the provisions of section 56(2)(vii)(c)(ii) of the Act, the Id. CIT(A) erred in facts and law in not appreciating that the rise in shareholding of the appellant is substantially due to inaction on part of his relatives to exercise the right issue of shares offered to them and that the addition made to that extent ought to have been excluded from the rigors of section 56(2)(vii)(c)(ii) of the Act.
As evident, the sole subject matter of dispute is addition as made by Ld. AO u/s 56(2)(vii)(c)(ii). The assessee being resident individual is stated to be director and a major shareholder in an entity namely M/s Kennington Fabrics Private Limited (KFPL).
1.3 The Ld. AR as well as Ld. CIT-DR advanced arguments along with written submissions. Reliance has been placed on various case laws. The Ld. AR has submitted that the case is squarely covered in assessee’s favor by the decision of this Tribunal in Sudhir Menon HUF V/s ACIT (45 taxmann.com 176) and various other decisions. The copies of the same have been placed on record. The Ld. CIT-DR, on the other hand, controverted the arguments put forth by Ld. AR.
1.4 We have carefully heard the rival submissions and perused relevant material on record. The judicial pronouncements as cited during the course of hearing have duly been deliberated upon. Our adjudication to the subject matter of appeal would be as given in succeeding paragraphs.
Assessment Proceedings
2.1 The dispute stems from the fact that the assessee was a director and a major shareholder in an entity namely M/s Kennington Fabrics Private Limited (KFPL). During the year, KFPL offered right issue and the assessee was allotted 3.95 Crores shares of KFPL at face value of Re.1/- each in the right issue. However, it was alleged by Ld. AO that the consideration of Re.1/- per share was less than fair market value (FMV) of shares as calculated in accordance with the provisions of Sec.56(2)(vii)(c)(ii) read with rule 11U & 11UA and therefore, the difference between FMV and the consideration paid by the assessee would be taxable in the hands of the assessee u/s 56(2)(vii).
2.2 The assessee, inter-alia, relied on the decision of Mumbai Tribunal in Sudhir Menon HUF (supra) wherein it was held that in case of proportionate allotment of shares, there would be no taxability u/s 56(2)(vii)(c)(ii).However, in case of disproportionate allotment of shares, there provisions may get attracted.
2.3 However, Ld. AO noticing that the percentage of share holding of the assessee in KFPL increased from 90.37% as on 31/03/2013 to 96.88% as on 31/03/2014, opined that there was disproportionate allotment of shares and therefore, the stated provisions would apply in assessee’s case.
2.4 Accordingly, Ld. AO worked out intrinsic value per share as on 31/03/2013 at Rs.11.85 per share on the basis of formula laid down in Rule 11U and 11UA which was as follows: –
(A-L) X (PV)
(PE)
Where A would represent book value of the assets in the balance-sheet, L would represent book value of liabilities shown in the balance-sheet, PE would be total amount of paid up equity share capital as shown in the balance-sheet and PV would be paid-up value of such equity shares.
2.5 Finally, the differential amount of Rs.10.85 per share (Rs.11.85 per share less issue price of Re.1/- per share) was added to the income of the assessee which resulted into an addition of Rs.4285.75 Lacs in the hands of the assessee.
Appellate Proceedings
3.1 During appellate proceedings, the assessee assailed the impugned additions by way of elaborate written submissions which have already been extracted in the impugned order. It was submitted that the shares were offered on right basis by KFPL on proportionate basis to all existing shareholders. The assessee subscribed to the right issue only to the extent of proportionate offer and no further. The attention was drawn to CBDT Circular No. 5 of 2010 dated 03/06/2010 which provided that the newly introduced provisions of Sec. 56(2)(vii) were anti-abuse measures. Similarly, CBDT Circular No.1 of 2011 provided that these provisions were introduced as a counter evasion mechanism to prevent laundering of unaccounted income. The provisions were intended to extend the tax net to such transactions in kind. The intent was not to tax the transactions entered into the normal course of business and trade, the profits of which are taxable under specific head of income.
3.2 On the strength of these arguments, the assessee submitted that initially it was holding 87.50 Lacs shares which constitute 90.37% shares of KFPL. During the year, vide board resolution dated 09/08/2013, the shareholders holding 7 shares were offered 8 shares at a price of Re.1/-per share. Vide another board resolution dated 06/03/2014, the shareholders holding 5 shares were offered 8 shares at price of Re.1/-per share. Accordingly, vide Board Resolution dated 09/08/2013, the assessee along with other shareholders was offered following shares: –
