Taxability of Share premium under Section 56(2)(viib) of Income Tax Act, 1961
Section 56(2)(viib) of the Income Tax Act,1961 was introduced in the Finance Act 2012 which requires a Company (issuer), not being a company in which the public are substantially interested, to issue shares at Fair Market Value (FMV). Any consideration received by such issuing Company in excess of the FMV, to the extent it exceeds the face value of such shall be liable to tax.
For the purpose of this section, FMV shall be the value, Higher of the following:
(a) as may be determined in accordance with such methods as may be prescribed( Methods prescribed under Rule 11UA are Book value Method (NAV) and Discounted Cash flow method); or
(b) 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,
In Rule 11UA(2)(b) the fair market value of the unquoted equity shares shall be determined by a merchant banker or an accountant as per the Discounted Free Cash Flow method.
There are many case laws where Assessing Officer disregarded the Value ascertained using Discounted Cash flow method in Valuation report and later in Appeals, this was allowed to Assessee. Since Assessee has option to choose any ot the two methods given in Rule 11UA, Assessing officer may use a method different from method used by the assessee which may become reason of disagreement.
Assessee-company was engaged in business of production and distribution of feature film and it had approached accredited investors to join in as equity partners and raised funds by issuing shares to said investors. Shares were issued at premium based on valuation using DCF method as mentioned in Rule 11UA by a Chartered Accountant as provided under rule 11UA(2).
The Assessing Officer had discarded the valuation report on the ground that valuation of the equity shares carried out by the assessee was based on projection of revenue which did not match with the actual revenues of the subsequent years. After invoking the provision of section 56(2)(viib), the Assessing Officer took fair market value of share premium at Nil and made addition.
The Commissioner (Appeals) upheld the said order. Later the Tribunal. The Tribunal held that if the assessee has opted for the DCF method, the AO cannot discard Valuation report issued by CA because CA is an expert prescribed under the Rule 11UA; however, the AO is well within his rights to examine the methodology adopted by the assessee and the underlying assumptions and if he is not satisfied, he can challenge the same and suggest necessary modifications. Therefore, The appeal of the appellant assessee is allowed.
Another similar judgement is of Vodafone M-Pesa Ltd. v. Deputy Commissioner of Income-tax Circle 8(3)(2), Mumbai in the ITAT Mumbai.
Assessee company had issued Shares after duly valuing shares based on Discount Cash Flow (DCF) method and valuation was done by a merchant banker.Assessing Officer was of view that valuer had not independently valued prospects of assessee company and merely relied on information supplied by assessee and accordingly, he proceeded to value fair market value of shares based on Net assets value added method – CIT(A) accepted DCF method adopted by assessee.
However, he proceeded to compare projections adopted by valuer with actual results or actual performance of assessee company in subsequent years and arbitrarily he held that business was growing at 40 per cent and hence, enterprise value of assessee should also be taken up by merchant banker. Thus, he determined share value at Rs. 11.17 per share and excess of amount received by assessee was treated as addition under section 56(2)(viib).
Assessing Officer and Commissioner (Appeals) were trying to evaluate accuracy of valuation at time of assessment, and this was not proper and also factual results of company were based on so many factors subsequent to adoption of projection and valuation and, thus, finding of Assessing Officer and Commissioner (Appeals) could not be upheld. The ITAT was of the view that for valuation of an intangible asset, only the future projections along can be adopted and such valuation cannot be reviewed with actuals after 3 or 4 years down the line. Accordingly, the grounds raised by the assessee are allowed.
However, Exemption has been given to Start Ups for the purpose of clause (viib) of sub-section (2) of section 56 of the Act. CBDT through Notification No. 13/2019 granted exemption to startup companies from angel tax w.e.f. 19.02.2019 if such companies fulfill the conditions specified in para 4 of the notification number G.S.R. 127(E), dated the 19th February, 2019.
For Details, Please check another article on “Exemption to Start Ups from the provisions of Sec 56(2)(viib) of IT Act,1961”